Pitfalls Of State And Local Contracting

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2 Pitfalls Of State And Local Contracting Breakout Session #: D16 Mike LaCorte and David Black Date: Tuesday, July 26 Time: 11:15am 12:30pm 1

3 Mike LaCorte Masters of Science in Taxation Florida Atlantic University Bachelor of Science in Accounting The Pennsylvania State University Contact Information: Mike LaCorte The Kenrich Group, LLC 1919 M Street, NW Suite 620 Washington, DC (202) mlacorte@kenrichgroup.com Mike LaCorte is a Principal in the Washington, D.C. office of The Kenrich Group. He is a Certified Public Accountant (CPA) licensed in Virginia and Certified Valuation Analyst (CVA) with over 12 years of experience in government contracts, accounting, auditing, and consulting. Mike has worked on a variety of consulting engagements related to government contracts, buy and sell side due diligence, forensic investigations, valuations, damages and lost profits calculations, and compliance assessments pertaining to the Cost Accounting Standards (CAS) and Federal Acquisition Regulation (FAR). Mr. LaCorte has assisted government contractors with: (1) regulatory consulting on compliance issues arising from the Cost Principles found in FAR Part 31 and the CAS, including the preparation of cost impact proposals; (2) the preparation and review of incurred cost submissions (ICSs); (3) assessments of accounting, purchasing, estimating, and earned value management systems; (4) indirect cost rate analyses for both Federal and state contractors; (5) preparation and review of Requests for Equitable Adjustment (REAs) and claims; (6) investigations; (7) developing pricing for proposals; (8) analysis of issues under bid protests for Federal and state/local contracts; and (9) assistance with the closeout of Federal contracts. This experience has provided him with substantial knowledge of the regulatory and audit requirements of government contractors. 2

4 Table Of Contents Overview Federal Acquisition Regulation FAR Provisions In State & Local Government Contracts Challenges For Contractors With REAs/Claims False Claims Act 4

5 Overview State and local government contracts present unique challenges. Federal rules and regulations (e.g., the Federal Acquisition Regulation) may be applicable. False Claims. Divergent rules. Understanding and navigating the distinctive characteristics of state and local contracts is essential for contractors who frequently do business with state and local governments. 5

6 Table Of Contents Overview Federal Acquisition Regulation FAR Provisions In State & Local Government Contracts Challenges For Contractors With REAs/Claims False Claims Act 6

7 Federal Acquisition Regulation The FAR is the primary regulation for use by all Federal Executive agencies in their acquisition of supplies and services with appropriated funds. FAR provisions may be incorporated into contracts with state and local governments, and will almost certainly be incorporated into contracts tied to Federal funding. Failure to comply with these provisions can have severe consequences. 7

8 Federal Acquisition Regulation (Cont.) Basics: Many state and local government contracts containing provisions from the FAR contain provisions from FAR Part 31. FAR Part 31 contains cost principles and procedures for: 1. Pricing of certain contracts, subcontracts, and modifications; and 2. Determination, negotiation, or allowance of costs. 8

9 Federal Acquisition Regulation (Cont.) FAR Part 31 includes information for: Classifying costs as either direct or indirect; Determining the allowability, reasonableness, and allocability of costs; Unallowable costs; and Principles for selected items of cost (e.g., alcohol). 9

10 Federal Acquisition Regulation (Cont.) Direct costs charged directly to a specific final objective or job (e.g., a contract). e.g., labor incurred directly in the performance of a contract. Indirect costs charged to intermediate or two or more final cost objectives. e.g., administrative costs, utility costs, or equipment maintenance. 10

11 Federal Acquisition Regulation (Cont.) FAR 31 contains certain requirements for a cost to be allowable. Allowable costs are costs that can be included in a contracted service or product. Allowable costs are reasonable, allocable, compliant with terms of contract, and satisfy other provisions of FAR 31. Expressly unallowable costs are specifically named as unallowable within applicable law, regulation, or the terms of the contract. e.g., alcohol and contributions/donations. 11

12 Table Of Contents Overview Federal Acquisition Regulation FAR Provisions In State & Local Government Contracts Challenges For Contractors With REAs/Claims False Claims Act 12

13 FAR Provisions In State And Local Government Contracts The cost principles of FAR may be found within state and local government contracts. For example, state Departments of Transportation (DOTs) oftentimes incorporate provisions from the FAR, as portions the contract funding are typically tied to Federal monies. Fundamentals and applicability: Uniform audit and accounting guide. Contractor cost certification of final indirect cost rates. 13

14 FAR Provisions In State And Local Government Contracts (Cont.) AASHTO Uniform Audit and Accounting Guide: Developed by the American Association of State Highway and Transportation Officials (AASHTO) Audit Subcommittee. Audit Subcommittee is comprised of senior audit representative from each state s transportation or highway department. Guide provides guidance for a compliant accounting system and indirect cost schedule. The guide was developed over several years (initially approved by AASHTO in 2001) with several updates over the years (the most recent iteration is the 2015 edition). 14

15 FAR Provisions In State And Local Government Contracts (Cont.) State Departments of Transportation: Several state DOTs reference the audit and accounting guide developed by the AASHTO Audit Subcommittee, including: Arizona Department of Transportation (ADOT). California Department of Transportation (Caltrans). Connecticut Department of Transportation (CTDOT). Florida Department of Transportation (FDOT). Minnesota Department of Transportation (MnDOT). South Carolina Department of Transportation (SCDOT). Texas Department of Transportation (TxDOT). Virginia Department of Transportation (VDOT). Guidance used primarily in auditing indirect cost rates. 15

16 FAR Provisions In State And Local Government Contracts (Cont.) Cost Principles Source: AASHTO Uniform Audit and Accounting Guide State departments of transportation (DOTs) often rely on FAR Part 31 for guidance when negotiating costs and reviewing project proposals with engineering consultants. The FAR contains cost principles and procedures for pricing contracts, subcontracts, and modifications to contracts. 16

17 FAR Provisions In State And Local Government Contracts (Cont.) STATE AND LOCAL COST PRINCIPLES When an engineering consultant presents FAR-compliant indirect cost rates and alternate rates based on state or local requirements, the indirect cost rate schedule should present the indirect cost rate in accordance with FAR Part 31, representing cost accounting practices consistently followed by the engineering consultant on Federally-funded contracts. When a consultant presents rates that are adjusted for state and local cost restrictions and/or alternative cost accounting methods, those adjustments and rates should be disclosed through notes to the FAR-compliant indirect cost rate schedule. Source: AASHTO Uniform Audit and Accounting Guide 17

18 Source: AASHTO Uniform Audit and Accounting Guide FAR Provisions In State And Local Government Contracts (Cont.) LISTING OF COMMON UNALLOWABLE COSTS FAR Reference Unallowable Costs & (b)(1) Advertising (f)(2) Trade Show Expenses (f)(2) Trade Show Labor (f)(5) Brochures and Other Promotional Material (d)(2) Souvenirs/Imprinted Clothing Provided to Public (f)(7) Membership in Civic and Community Organizations... 18

19 FAR Provisions In State And Local Government Contracts (Cont.) State Departments of Transportation: Several state DOTs require prime contractors and subcontractors to certify that all proposed indirect costs are allowable in accordance with the cost principles of the FAR, including: Arizona Department of Transportation (ADOT). Florida Department of Transportation (FDOT). New Jersey Department of Transportation (NJDOT). New York state Department of Transportation (NYSDOT). Vermont Department of Transportation (VTrans). Virginia Department of Transportation (VDOT). Many times, AASHTO guidance used for audit of indirect cost rates. 19

20 FAR Provisions In State And Local Government Contracts (Cont.) VERMONT AGENCY OF TRANSPORTATION INDIRECT COST CERTIFICATION FORM 1.) All costs included in the indirect cost rates are allowable in accordance with the cost principles of the Federal Acquisition Regulations (FAR) of title 48, Code of Federal Regulations (CFR), part ) This indirect cost rate does not include any costs which are expressly unallowable under the Cost principles of the FAR of 48 CFR

21 FAR Provisions In State And Local Government Contracts (Cont.) VDOT Contractor Cost Certification of Final Indirect Cost Rates All costs included in this proposal to establish final indirect cost rates are allowable in accordance with the cost principles of the Federal Acquisition Regulations (FAR) of title 48, Code of Federal Regulations (CFR), part 31. This proposal does not include any costs which are expressly unallowable under the cost principles of the FAR of 48 CFR

22 Table Of Contents Overview Federal Acquisition Regulation FAR Provisions In State & Local Government Contracts Challenges For Contractors With REAs/Claims False Claims Act 22

23 Challenge For Contractors With REAs/Claims Typical circumstances where FAR provisions can be problematic to state and local contractors include Requests for Equitable Adjustment (REAs) or claims. REAs and claims often create situations where FAR Part 31 and other provisions applicable to cost reimbursable type contracts become applicable to fixed price contracts. REAs and claims are often complex. Specialists are usually required for both the contractor in preparation of an REA or claim as well as for the government in auditing the REA or claim. 23

24 Challenge For Contractors With REAs/Claims (Cont.) Unallowable costs must be excluded from an REA or claim when the FAR is incorporated into a state or local government contract. Direct costs what types of costs are direct to an REA or claim? Costs which are traditionally indirect may be treated as direct for purposes of the REA or claim. Certain direct costs are higher risk than others (e.g., construction equipment costs). 24

25 Challenge For Contractors With REAs/Claims (Cont.) Indirect costs what are the appropriate indirect costs to include in an REA or claim? If costs which are typically treated as indirect are treated as direct for an REA or claim, be sure to remove such costs from claimed indirect cost rates. Estimates may be appropriate. What amount of profit is appropriate? If a contractor critically considers risk and capital needs in their profit computation and maintain well documented reasoning, profit is more likely to be sustained. 25

26 Challenge For Contractors With REAs/Claims (Cont.) Common reasons for government auditors to take exception to costs: Claiming costs which are unallowable / claiming directly associated unallowable costs. Inadequate / incomplete supporting documentation. Mischarging of costs between projects, between cost codes within a project, or between accounting periods. 26

27 Challenge For Contractors With REAs/Claims (Cont.) Common reasons for government auditors to take exception to costs: Claiming costs in violation of contract terms. Inconsistency in how similar costs are treated. Unreasonableness of cost incurred in proportion to benefit received. Inconsistency between how costs are recorded and a contractor s established cost accounting practices. 27

28 Challenge For Contractors With REAs/Claims (Cont.) Common pitfalls for REAs and claims: Inadequate support. Missing or incomplete documentation. Estimates. Poorly documented rationale of basis for estimates. Inability to appropriately account for government caused increases in costs. Very common for contractors which service only fixed price contracts. Inclusion of unallowable costs. 28

29 Challenge For Contractors With REAs/Claims (Cont.) Government auditor s exception to costs can lead to problems. Corrective actions include: Reduction or withholding of progress payments. Assessment of penalties and/or interest. Recommendations for suspension or debarment. Alleged false claims act violations. Criminal and/or civil penalties. 29

30 Table Of Contents Overview Federal Acquisition Regulation FAR Provisions In State & Local Government Contracts Challenges For Contractors With REAs/Claims False Claims Act 30

31 False Claims Act Federal law used by the Federal Government and private citizens against individuals and companies who commit fraud against governmental programs. Federal Government s primary means of combatting fraud. Penalties: Treble damages plus $5,500-$11,000 for each false claim. Includes qui tam (i.e., whistleblower) provisions. Federal Government has recovered approximately $48.4 billion under the FCA between 1987 and 2015 (approximately 70% from qui tam cases). 31

32 False Claims Act (Cont.) False claims cases commonly involve: False statements or certifications in the course of the government procuring goods and services. Medicare and Medicaid false claims. Examples of the types of false claims include: Lack of compliance with contract specifications. Health care fraud. Charging for services that were not performed. Defective pricing. Mischarging labor hours/rates. 32

33 False Claims Act (Cont.) All 50 states and Washington, D.C. have some form of False Claim, False Statement, or other fraud statute. Certain cities have local False Claims Acts (e.g., New York City, Chicago, Philadelphia). Other fraud statutes cover areas such as medical fraud, fraud related to wages and other compensation, taxes, and insurance. Many jurisdictions include civil or criminal penalties in their statutes. Some jurisdictions include both civil and criminal penalties in their statutes. 33

34 False Claims Act (Cont.) Medicaid only state FCAs: Colorado Connecticut Louisiana Maryland Michigan New Hampshire Texas Washington 34

35 False Claims Act (Cont.) States with FCAs as strong as the Federal FCA in recovering Medicaid money: California Colorado Connecticut Georgia Hawaii Illinois Iowa Massachusetts Minnesota Montana New York Rhode Island Tennessee Texas Washington 35

36 False Claims Act (Cont.) California state FCA. Has been utilized in a wide variety of cases, both Medicaid and non-medicaid. Considered as strong as the Federal FCA in recovering Medicaid money. Penalties: Treble the state s damages plus a fine between $5,500 and $11,000 for each false claim. Has qui tam provision. Whistleblower reward: 15%-33% of any recovery (and 25%-50% of the settlement if the state does not intervene). 36

37 False Claims Act (Cont.) California state FCA Example. In 2014, a settlement was reached in a qui tam suit that was filed against Office Depot by a former employee who claimed the company violated the terms of contracts used by 1,200 state government agencies to purchase pens, ink, furniture and other goods. Office Depot settled the lawsuit for approximately $78 million (recipients including California state government agencies, the whistleblower and the attorney s of the whistleblower). 37

38 False Claims Act (Cont.) Florida state FCA. Penalties: Treble the state s damages plus a fine between $5,500 and $11,000 for each false claim. Has qui tam provision. Whistleblower reward: 15%-25% of any recovery (and 25%-30% of the settlement if the state does not intervene). 38

39 False Claims Act (Cont.) Florida state FCA Example. In 2012, McKesson Corporation settled a suit as part of a global settlement totaling more than $150 million, including more than a $10 million settlement for the state of Florida. The settlement resolved allegations that McKesson Corporation violated both Federal and state FCAs by reporting inflated pricing data for prescription drugs, causing state Medicaid programs to overpay McKesson. 39

40 False Claims Act (Cont.) Illinois state FCA. Considered as strong as the Federal FCA in recovering Medicaid money. Penalties: Treble the state s damages plus a fine between $5,500 and $11,000 for each false claim. Has qui tam provision. Whistleblower reward: 15%-25% of any recovery (and 25%-30% of the settlement if the state does not intervene). 40

41 False Claims Act (Cont.) Illinois state FCA Example. In 2012, GlaxoSmithKline (GSK) settled with the Federal Government and several states for $3 billion as part of the largest healthcare fraud settlement in U.S. history, including $25 million settlement for the state of Illinois. GSK allegedly engaged in illegal schemes in marketing and pricing its drugs to sell to manufacturers. 41

42 Table Of Contents Overview Federal Acquisition Regulation FAR Provisions In State & Local Government Contracts Challenges For Contractors With REAs/Claims False Claims Act 42

43 Questions 43

44 Contact Information Mike LaCorte Phone: (202)

45 Disclaimer This presentation has been prepared for discussion purposes only. This presentation is not intended to be used in litigation. The context of this presentation is not specific to any particular litigation. Because each litigation is specific to its own facts and circumstances, it would be unwise and even misleading to take a passage of static words or slides from this presentation and assume that it can be applied to a particular circumstance without applying reasoned judgment to the specific facts and circumstances of the situation. 45