City and County of San Francisco

Transcription

1 City and County of San Francisco Office of the Controller City Services Auditor AIRPORT COMMISSION: Better Oversight Is Required to Improve the Change Management Process for the New Air Traffic Control Tower January 13, 2015

2 OFFICE OF THE CONTROLLER CITY SERVICES AUDITOR The City Services Auditor Division (CSA) was created in the Office of the Controller through an amendment to the Charter of the City and County of San Francisco (City) that was approved by voters in November Charter Appendix F grants CSA broad authority to: Report on the level and effectiveness of San Francisco s public services and benchmark the City to other public agencies and jurisdictions. Conduct financial and performance audits of city departments, contractors, and functions to assess efficiency and effectiveness of processes and services. Operate a whistleblower hotline and Web site and investigate reports of waste, fraud, and abuse of city resources. Ensure the financial integrity and improve the overall performance and efficiency of city government. CSA may conduct financial audits, attestation engagements, and performance audits. Financial audits address the financial integrity of both city departments and contractors and provide reasonable assurance about whether financial statements are presented fairly in all material aspects in conformity with generally accepted accounting principles. Attestation engagements examine, review, or perform procedures on a broad range of subjects such as internal controls; compliance with requirements of specified laws, regulations, rules, contracts, or grants; and the reliability of performance measures. Performance audits focus primarily on assessment of city services and processes, providing recommendations to improve department operations. CSA conducts audits in accordance with the Government Auditing Standards published by the U.S. Government Accountability Office. These standards require: Independence of audit staff and the audit organization. Objectivity of the auditors performing the work. Competent staff, including continuing professional education. Quality control procedures to provide reasonable assurance of compliance with the auditing standards. For questions regarding the report, please contact Director of City Audits Tonia Lediju at Tonia.Lediju@sfgov.org or or CSA at Audit Team: Mark delarosa, Lead Audit Manager Nicholas Delgado, Audit Manager Debbie Richardson, Audit Manager Jonathan Collum, Auditor-in-Charge Cheryl Lam, Staff Auditor Freddy Padilla, Staff Auditor

3 City and County of San Francisco Office of the Controller City Services Auditor Airport Commission: Process for the New Air Traffic Control Tower January 13, 2015 Purpose of the Audit The audit assessed the adequacy of the internal controls and oversight over the change management process for the Replacement Airport Traffic Control Tower and Integrated Facilities (ATCT) project at San Francisco International Airport. The audit examined the controls and oversight of the Airport Commission (Airport) and its construction manager, T2 Partners. The audit also assessed whether Hensel Phelps Construction Company, the project s design-builder, complied with certain cost and other provisions of its contract with the City and County of San Francisco (City). Highlights The construction manager and the Airport insufficiently review proposed change order (PCO) requests submitted by the contractor and its subcontractors. Further, the contractors and subcontractors submitted insufficient documentation to substantiate their charges for change order work. The audit found that: The contractor submitted insufficient documentation to support some labor, equipment, materials, and lower-tier subcontractor charges for change order work. The contractor s labor surcharge exceeded the Caltrans rate of 12 percent of regular nonovertime wages. The contractor improperly charged the Airport for rental of equipment with a fair market value of less than $1,000 as well as job vehicles. Such charges are included in the contractor s markup for overhead and profit, so should not be separately charged. The Airport did not always review or approve change orders before work was performed. Also, the Airport did not always prepare the required forms, such as a PCO form and an Authorization for PCO form. Consequently, the Airport has no record that it authorized the contractor to proceed with some of the work. The Airport sometimes did not use the required change management process and substantiated costs in ways not outlined in the change management procedures. In almost all cases, no evidence exists to show that the Airport prepared or conducted negotiations with the contractor. Certain provisions in the contract are inappropriate for the designbuild project delivery method that the Airport used for the ATCT project. Recommendations The report includes 17 recommendations for the Airport to improve its oversight and management of change order work. Specifically, the Airport should: Ensure that all PCO packages contain sufficient detail to support its labor, equipment, and material charges. Properly review labor charges to ensure that the labor surcharge does not exceed 12 percent of regular nonovertime wages or is as otherwise specified by Caltrans. Review equipment charges to ensure that all are allowable. Review, prepare for, and conduct negotiations, and approve PCOs, before allowing the contractor to proceed with the work. Ensure the design-builder is allowed by the contract to recover legitimate design costs through change orders. Copies of the full report may be obtained at: Office of the Controller City Hall, Room Dr. Carlton B. Goodlett Place San Francisco, CA or on the Internet at

4 Page intentionally left blank.

5

6 Page intentionally left blank.

7 TABLE OF CONTENTS Glossary iii Introduction 1 Chapter 1 The Contractor Provided the Airport With Supporting Documentation for Proposed Change Orders That Is Inadequate to Ensure the Accuracy and Compliance of Costs Charged 11 Finding 1.1. Contractor documentation is sometimes insufficient to support costs for labor, equipment, materials, and lower-tier subcontractor work charged for proposed change orders 12 Finding Documentation supporting labor charges for proposed change orders is sometimes insufficient 13 Finding Documentation supporting equipment charges for proposed change orders is sometimes insufficient 15 Finding Documentation supporting materials charges for proposed change orders is sometimes insufficient 16 Finding Documentation supporting lower-tier subcontractor charges for proposed change orders is sometimes insufficient 17 Finding 1.2. The Airport accepted excessive labor surcharges from subcontractors under proposed changed orders 18 Finding 1.3. The Airport accepted unallowable equipment charges under proposed change orders 20 Finding 1.4. The Airport allowed the misclassification of equipment in two proposed change orders. 21 Chapter 2 The Airport Should Better Administer and Oversee the Review, Negotiation, and Approval of Proposed Change Orders 23 Finding 2.1. The Airport sometimes substantiated costs through a process other than the required change management procedures 23 Finding 2.2. The Airport did not perform timely reviews of proposed change order requests 24 i

8 Finding 2.3. Proposed change order documentation did not contain evidence that cost negotiations were prepared for or held by the Airport 25 Finding 2.4 The construction manager did not always prepare all of the required change management forms 27 Chapter 3 The Airport Needs to Modify the Contract Language to Make It in Accordance With the Design-Build Project Delivery Method 29 Finding 3.1 Some provisions in the contract are inappropriate for design-build projects. 29 Appendix Department Response A-1 ii

9 GLOSSARY OF TERMS Airport ATCT project Caltrans CCO City CSA FAA Hensel Phelps PCO SFO Airport Commission Replacement Air Traffic Control Tower and Integrated Facilities project California Department of Transportation Contract Change Order City and County of San Francisco City Services Auditor Division of the Office of the Controller of the City and County of San Francisco Federal Aviation Administration Hensel Phelps Construction Company Proposed Change Order San Francisco International Airport iii

10 Page intentionally left blank. iv

11 INTRODUCTION Audit Authority Background This audit was conducted under the authority of the Charter of the City and County of San Francisco (City), Section and Appendix F, which requires that the City Services Auditor (CSA) of the Office of the Controller conduct periodic, comprehensive financial and performance audits of city departments, services, and activities. The Airport Commission (Airport) operates San Francisco International Airport (SFO), which is the San Francisco Bay Area s largest airport, serving more than 41 million domestic and international passengers yearly. In fiscal year , SFO surpassed its previous record year for passenger traffic, serving 44.3 million passengers. To ensure that SFO continues to meet customer service standards as it experiences continual passenger traffic growth, the Airport created a five-year capital plan to identify high-priority capital needs, which include projects that will build new facilities, improve existing facilities, renovate buildings, repair or replace infrastructure, preserve assets, enhance safety and security, develop systems functionality, and perform needed maintenance. The five-year capital plan includes significant investments in terminal improvements, including a new Replacement Air Traffic Control Tower and Integrated Facilities (ATCT) project that will replace the existing control tower in Terminal 2, create a secure and nonsecure corridor, an integrated facility base building, and a new club lounge for Delta Airlines. Standing at 221 feet tall, the new tower is located between Terminals 1 and 2 and will replace the existing control tower that has been in operation since With funding from the Airport and the Federal Aviation Administration (FAA), the new control tower is being built to satisfy specific technical and site requirements as well as stringent seismic, safety, and security design standards. The ATCT project began in 2012 and is expected to be operable in Fall

12 Project Stakeholders For this project, the Airport contracted with T2 Partners, a joint venture of Parsons Transportation Group, Inc., EPC Consultants, Inc., and the Allen Group, LLC (T2 Partners), for construction management services for a total of $4.6 million. The Airport also contracted with Hensel Phelps Construction Company (Hensel Phelps) to serve as the design-builder for $122.2 million. The stakeholders for the ATCT project include the FAA, the Airport commissioners who govern the Airport, the Design and Construction Division of the Airport, T2 Partners, Hensel Phelps, and its subcontractors. The stakeholders organizational structure for the project is detailed in Exhibit 1. EXHIBIT 1 Organizational Structure of Project Stakeholders Airport Commission Airport Director Design & Construction Division Deputy Airport Director Air Traffic Control Tower Project Manager Hensel Phelps Construction Company Design-Builder * T2 Partners Project Manager/Construction Manager Subcontractors *Note: Although both T2 Partners and Hensel Phelps report to the Airport, Hensel Phelps is managed by T2 Partners, which acts as the construction manager for this project, on behalf of the Airport. Source: T2 Partners. 2

13 Project Delivery Method The ATCT project is considered a design-build project, which differs from the more traditional design-bid-build project delivery method 1. The design-bid-build project delivery method requires that the design and construction of a given project have separate contracts and be executed by separate entities. Construction occurs after design is completed, and the project is then awarded to the contractor for construction. In contrast, under the design-build delivery method, there is one contract with the design-builder as the single entity that provides both the design and construction services to the owner. Because design and construction are both executed by one entity, this project delivery method builds an alliance between the designers and builders that aims to increase efficiency, effectiveness, and overall quality of the project being delivered. Exhibit 2 shows the structural differences between the two project delivery methods. EXHIBIT 2 Design-Bid-Build Versus Design-Build Project Delivery Methods Source: Design-Build Institute of America 1 The project delivery method is the way in which a construction project will be designed and constructed to achieve the satisfactory completion of the project from conception to occupancy. 3

14 Hensel Phelps Construction Company T2 Partners The City entered into the contract with Hensel Phelps as the design-builder for the ATCT project in April 2012, with the Airport managing the contract for the City. The initial contract between Hensel Phelps and the Airport was for $9.7 million to finance preconstruction services, design services, and an appropriate owner s allowance. 2 As designs continue to be finalized after construction has begun, the contract amount will be continuously updated for the Commission at each award of additional scope, eventually amounting to $122.2 million. As mandated by the contract between T2 Partners and the City, T2 Partners must provide construction management services that include the overall planning, coordination and oversight of the ATCT project. As the construction manager for this project, T2 Partners is tasked with the review of change orders. Specifically, according to the contract terms, T2 Partners must: Administer the evaluation and negotiation of change orders and prepare and process change orders and contract modifications. The Airport Project Manager must review and approve entitlement for change order requests prior to [T2 Partners ] response to the contractor. According to T2 Partners, Hensel Phelps contracts most of the project work to subcontractors for both design and construction services. The project uses two types of change orders: 1) Type 1 change orders, and 2) exposure allowance which are processed as proposed change orders (PCOs), according to the Airport and T2 Partners. Like traditional change orders in a design-bid-build project the legal means to change a contract by adding to, deleting from, or otherwise altering the work as originally set forth in the contract between the owner and the contractor the review of change orders is necessary and important. 2 An owner s allowance was established for initial construction activities to inform the design process, including selective demolition, utility/site investigations and facility condition assessments, and other critical project activities. 4

15 Type 1 Change Orders According to the Airport and T2 Partners, Type 1 change orders are used for any needed changes in designs as the project progresses. As designs continue to be finalized for this design-build project, these Type 1 change orders are used to account for such changes. The Airport processes Type 1 change orders when necessary design changes are realized. The Airport contacts Hensel Phelps to provide a quote for the additional scope or out-of-scope work, holds negotiations if the price is not mutually agreeable between the contractor and the Airport, and when a price is agreed upon and approved by the Airport, T2 Partners prepares a PCO and notifies Hensel Phelps to proceed with work. T2 Partners then submits the PCO as a contract change order. Once Airport management approves the Type 1 change order, Hensel Phelps s contract is increased to cover the additional costs. Exposure Allowances According to T2 Partners, although design changes are processed as Type 1 change orders, other changes are established and processed through the use of exposure allowances, including construction-related changes. According to Hensel Phelps and the Airport, in addition to the defined scopes of work, Hensel Phelps and the Airport anticipate certain construction scopes that cannot be accurately estimated or quantified. These undefined scopes of work are covered with the preapproved exposure allowance. Further according to the Airport, this allowance is only known between the Airport and Hensel Phelps and is essentially a contingency, or an amount set aside for unforeseen circumstances or events that may occur throughout the construction of the project. Because design and construction occur simultaneously, the construction subcontractors only bid on and are awarded defined scopes of work. Once a scope of work is defined, it is compiled into a trade bid package with the final award amount and assigned an exposure allowance, which is then submitted to the Commission for approval. Each approved subcontract is then awarded to the lowest bidder. Exhibit 3 depicts the process to establish an exposure allowance and how Type 1 change orders are approved. 5

16 EXHIBIT 3 Exposure Allowance and Type 1 Change Order Establishment Process Type 1 Change Order Exposure Allowance Airport identifies need for added scope of work Airport issues initial PCO authorizing Hensel Phelps to proceed with work Airport directs Hensel Phelps to provide cost proposal for out-of-scope work Hensel Phelps submits change estimate, with cost proposal and description of work Initial scope of work is established Hensel Phelps anticipates unquantified and undefined or additional construction scope Negotiations occur if price is not agreed upon by both parties Airport reviews trade bid package with exposure allowances An exposure allowance is estimated T2 Partners prepares Finding of Fact, estimate, Authorization Letter, and PCO Airport Management approves CCO T2 and Airport approves changes and notifies Hensel Phelps to proceed T2 Partners prepares contract change order (CCO) Hensel Phelps issues RFP for subcontractor services Hensel Phelps and Airport selects lowest bidder Hensel Phelps s contract amount is increased Lowest bidder awarded trade bid package subcontract Airport Commission reviews and increases Hensel Phelps contract amount Source: T2 Partners Change Order Process If a subcontractor begins work and encounters an unforeseen circumstance or a situation that requires additional work outside the original scope it was awarded to perform, the subcontractor may submit a request to Hensel Phelps to use the exposure allowance. Per the contract s general conditions, this request is required to include a cost estimate by the subcontractor for the additional work. Exhibit 4 shows the process to request the use of an exposure allowance. This includes the subcontractor s initial request submittal with a cost proposal for additional work, Hensel Phelps s and T2 Partners review of the request, negotiations, and approval. 6

17 EXHIBIT 4 Process to Request Use of an Exposure Allowance Subcontractor requires use of exposure allowance for unforeseen work, outside base bid Subcontractor submits estimate for additional work to Hensel Phelps Hensel Phelps submits Authorization Request to T2 Partners to use exposure allowance Hensel Phelps reviews cost estimate T2 Partners reviews Authorization Request for merit and appropriate support Cost negotiations occur T2 Partners and Airport approve use of exposure allowance with PCO T2 Partners prepares Finding of Fact, Authorization Letter and PCO PCO issued to Hensel Phelps to proceed with use of exposure allowance Source: T2 Partners Although the exposure allowance has already been set and allotted by the Airport, the request to use the allowance is processed as a PCO. By stringently reviewing exposure allowances, the Airport can ensure that the PCOs are used correctly, reasonably, and effectively. Objectives The audit s objectives were to determine whether: 1. The Airport, T2 Partners, and Hensel Phelps comply with cost and other provisions of their 7

18 agreement and the Airport s draft policies and procedures on change orders and the usage of exposure allowances. 2. The Airport adequately reviews Type I change orders and usage of exposure allowances to ensure that they are aligned with contract requirements in terms of cause and pricing, are accurate, and contain the required supporting documentation. 3. The Airport adheres to the department s draft policies and procedures for change orders and exposure allowances. 4. The Airport s construction management processes, procedures, and controls over change orders are adequate. Scope and Methodology The audit examined the Airport s internal controls around its change management process during the period of April 11, 2012 through April 15, To conduct the audit, the audit team: Interviewed key project personnel to gain an understanding of the proposed change order process for Type 1 change orders and exposure allowance usages. Reviewed the Airport s policy and procedures as they pertain to change management. Reviewed the Airport s contract with Hensel Phelps, specifically the general conditions as they relate to proposed change orders. Reviewed the Airport s contract with T2 Partners to determine the responsibilities of the latter related to management of proposed change orders. Purposefully selected a sample of 43 proposed change orders (18 percent) from a population of 241 based on risk areas such as dollar amount of proposed change order, frequency of subcontractor used, time elapsed between subcontractor s request submittal and Airport s review, and time span of project. 8

19 Verified the proper supporting documentation and conformance with provisions set forth in the contract s general conditions and in the Airport s draft policies and procedures. Statement of Auditing Standards This performance audit was conducted in accordance with generally accepted government auditing standards. These standards require planning and performing the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for the findings and conclusions based on the audit objectives. CSA believes that the evidence obtained provides a reasonable basis for the findings and conclusions based on the audit objectives. 9

20 Page intentionally left blank. 10

21 CHAPTER 1 The Contractor Provided the Airport With Supporting Documentation for Proposed Change Orders That Is Inadequate to Ensure the Accuracy and Compliance of Costs Charged Summary The Airport does not ensure the proposed change order (PCO) packages contain adequate documentation to support labor, equipment, materials, and lower-tier subcontractor 3 charges. Because of the insufficient documentation, neither the Airport nor the audit team can verify that such charges are accurate and comply with contract provisions. A review of the 43 PCO packages found: Some PCOs had no detail of labor charges to sufficiently verify the base rate, labor surcharge, or fringe benefits charged for those who worked on the project. For the subcontractors who did provide a labor breakdown to support their respective PCO packages, the labor surcharge exceeded the allowable California Department of Transportation (Caltrans) labor surcharge rate. Subcontractors charged for certain unallowable costs. Equipment was misclassified as materials in two PCOs reviewed. Because change orders may represent a sizable portion of the project s overall costs, it is imperative that the Airport ensures that costs are supported by sufficient documentation and comply with general conditions. A lack of sufficient documentation and lack of compliance with the contract s general conditions increases the risk of improper payments by the Airport to its contractors. 3 A lower-tier subcontractor is a subcontractor hired by a higher-tier subcontractor to perform work. 11

22 Finding 1.1 Contractor documentation is sometimes insufficient to support costs for subcontractor labor, equipment, materials, and lower-tier subcontractor work charged for proposed change orders. A review of 43 PCOs found that PCO packages lacked sufficient detail to substantiate the charges made by the subcontractor to the Airport. According to the contract s general conditions, subcontractors are required to provide supporting documentation or a detailed breakdown for the charges they are submitting to the Airport for change order work. Without such support, neither the Airport nor the audit team can verify that such costs are reasonable, in compliance with the contract, or accurate. PCO packages have insufficient documentation to support labor rates charged by subcontractors, equipment charges, material charges, and when applicable, lower-tier subcontractor charges. These insufficiencies will be discussed in more detail in subfindings through Exhibit 5 indicates when the cost proposal should have been provided for review by both the design-builder and by the subcontractors and what should have been provided in the cost proposal. 12

23 EXHIBIT 5 Change Order Documentation Required of Each Subcontractor Subcontractor requests to use exposure allowance for unforeseen work or work outside the base bid Subcontractor submits cost proposal with supporting documentation to designbuilder Design-builder reviews cost proposal and submits to T2 Partners Supporting documentation should have detailed breakdown for: Labor Equipment Materials Any lower-tier subcontractors T2 Partners and Airport review, approve, and direct subcontractor to proceed with work Source: Airport s draft policies and procedures, contract s general conditions, and project personnel Finding Most documentation for labor rates provided only a lump-sum rate, without a breakdown. Documentation supporting labor charges for proposed change orders is sometimes insufficient. In 19 (44 percent) of the 43 PCOs reviewed, labor charges lacked an adequate breakdown of labor rates. Insufficient detail was provided for base wages, labor surcharges, and fringe benefits received by workers. Instead, a lump-sum labor rate was used for each trade and employee who worked on the project. For example, for PCO 215, the Airport paid $376,429 without a price breakdown. The PCO was created for the design and installation of electrical work and systems for the Delta Club, which is a portion of the ATCT project. The only documentation to support the charges in PCO 215 was a general price quote by the 13

24 subcontractor with the scope of work included in the quoted cost. According the Airport s Draft Policies and Procedures for change management, Section , change orders must have supporting price breakdown details for each item in the change order to allow for the review of the necessity and reasonableness of the costs and amounts proposed. Further, according to the contract s General Conditions, subparagraph 6.03E, when submitting a change order request, the cost proposal shall include a complete itemized breakdown of labor. Without an adequate labor breakdown, neither the Airport or T2 Partners can verify that base wages do not exceed prevailing wages or that fringe benefits do not exceed those of the local governing trade organizations, both of which are required by the contract. 4 Insufficient documentation exists to verify whether foremen labor charges were for working foremen or supervisory foremen. The contract prevents the contractor from being paid for supervisory foremen s labor. In some cases, insufficient documentation exists to support working or supervisory foremen labor. In 14 (33 percent) of the 43 PCOs reviewed, it was unclear whether the foremen labor charges were allowable or unallowable. There is no documentation in the PCO package that would allow the Airport to verify the foremen s role, whether working or supervisory. The contract s General Conditions, subparagraph 6.06B.1, prohibits the contractor from charging supervisory foremen labor because it is included in the 15 percent markup for overhead and profit that subcontractors receive. Without adequate supporting documentation, the Airport may have overpaid the subcontractor by paying for supervisory foremen labor charges. 4 The contract s General Conditions, Section 6.06A.1, state that labor rates shall not exceed those prevailing wages plus any actual payments by the employer for its workers health and welfare, pension, vacation, and similar purposes that do not exceed the charges of the local governing trade organizations for the trades employed. 14

25 Recommendations The Airport Commission should require all contractors, in the current contract and in all future contracts to: 1. Provide a detailed breakdown of labor rates, fringe benefits, and labor surcharge for each Proposed Change Order. 2. Document all foremen labor charges and ensure that foremen costs are for working foreman, not supervisory foremen. Finding A majority of PCOs lacked detail to support subcontractor equipment charges. Documentation supporting equipment charges for proposed change orders is sometimes insufficient. In 21 (49 percent) of the 43 PCOs reviewed, insufficient detail was provided to verify the accuracy of equipment charges. Specifically, the documentation T2 Partners provided to the audit team did not indicate in sufficient detail the specific piece of equipment used by the subcontractor. For example, a compressor was charged as equipment used in multiple PCOs. However, the PCO package did not contain documentation identifying the type or model used. Depending on the type of compressor, Caltransspecified rates range from $5 an hour to more than $100 an hour. The contract s General Conditions, subparagraph 6.03E, require that, at a minimum, the design-builder and subcontractor must provide an equipment breakdown by make, type, size, rental rate, and equipment hours. Because equipment charges are not supported by sufficiently detailed documentation, the audit could not determine, as the contract requires, whether the billed amount was the lower of the cost per either Caltrans Labor Surcharge and Equipment Rental Rates or the Cost Reference Guide for Construction Equipment. 5 Without sufficient documentation of these charges, the Airport cannot be assured that the subcontractor charges the correct amount for the equipment used. 5 This requirement is in the contract s General Conditions, Subparagraph 6.06A.3. 15

26 Recommendation 3. The Airport Commission should ensure all contractors, in the current contract and in all future contracts, to provide a detailed estimate of equipment charged to each Proposed Change Order with make, type, size, equipment rental rates, and rental hours listed. Finding The material breakdown did not have any detail for the quantities of materials charged. Documentation supporting materials charges for proposed change orders is sometimes insufficient. In 7 (16 percent) of 43 PCOs reviewed for materials charges, the PCO package contained no invoices or support to substantiate the subcontractor s materials charges. For example, PCO 171 was used to pay for the electrical equipment removal and relocation for the demolition in Terminal 2. For this PCO, material charges included supports as materials used. Although there are quantities provided, there is insufficient detail regarding the type of supports used. According to the contract s General Conditions, Subparagraph 6.03E, at a minimum, the cost proposals provided by the subcontractor must include material quantities and type of products. Also, as stated in the General Conditions, subparagraph 6.06A.2, the Airport will only pay for materials furnished by the design-builder and directly required for performing the change order work. Without sufficient documentation of the type and quantities of materials used, the Airport cannot be assured that it only pays for materials used directly for the change order work. Recommendation 4. The Airport Commission should require all contractors, in the current contract and in all future contracts, to provide a detailed estimate of materials charged to each Proposed Change Order with type and quantities listed. 16

27 Finding The subcontractor charged a lump-sum amount with no additional detail regarding the work performed by the lower-tier subcontractor. Documentation supporting lower-tier subcontractor charges for proposed change orders is sometimes insufficient. In 9 (21 percent) of 43 PCOs reviewed that had work performed by a lower-tier subcontractor, the PCO package lacked supporting documentation from the lower-tier subcontractor to verify if costs were accurate. For example, in PCO 22, the subcontractor charged for $1,000 of saw-cutting work performed by the lower-tier subcontractor due to unforeseen asphalt and concrete thickness at a water trench location. In this PCO, the only documentation to support the $1,000 charge provided in the PCO package was a line item containing the lump-sum by the subcontractor. There were no invoices or quotes from the lower-tier subcontractor itemizing the cost. This charge was then further passed through to Hensel Phelps and ultimately paid for by the Airport. According to the contract s General Conditions, subparagraph 6.03E.1, all subcontractors, lower-tier subcontractors, and the design-builder are required to include an itemized breakdown of labor, material, equipment, taxes, insurance, bonds, and markup for overhead and profit. For work performed by lower-tier subcontractors, lump-sum rates from the subcontractor were provided without estimates or invoices from the lower-tier subcontractor. This increases the risk that the Airport could pay more for services than the contract allows. Exhibit 6 summarizes the types of PCO costs with insufficient supporting documentation to support charges. 17

28 EXHIBIT 6 Areas of Insufficient Documentation of Costs in Proposed Change Orders PCO Charge Type Supporting Documentation Lacked General Labor A labor breakdown by base rate, labor surcharge, and fringe benefits Foremen Labor Documentation indicating whether foremen were supervisory or working Equipment Detail indicating make, type, and size Materials Documentation indicating type and quantity of materials Lower-tier Detailed breakdown by lower-tier subcontractor Subcontractor Source: Based on audit testing Recommendation 5. The Airport Commission should ensure that all lower-tier subcontractors, in the current contract and in all future contracts, provide a detailed breakdown of their labor, equipment, and materials charges, as required by the contract s general conditions. Finding 1.2 The Airport accepted excessive labor surcharges from subcontractors under proposed changed orders. Although there was insufficient documentation to determine the accuracy of labor charges submitted by Hensel Phelps subcontractors for 44 percent of the selected PCO packages reviewed, for those subcontractors that did provide detailed labor breakdowns, labor surcharge 6 rates exceeded the allowable rate. Most labor surcharges significantly exceeded the allowed rate of percent. Of the 19 construction subcontractors selected for review by the audit, the design-builder could provide labor breakdown detail for only 7 (37 percent). The audit found that all 7 construction subcontractors who provided labor breakdowns had labor surcharge rates that exceeded the allowable Caltrans labor surcharge rate of 12 to13 percent. Five of the 7 were approximately 21 to 26 percent of the taxable wage 6 A labor surcharge is added to labor charges for each PCO containing labor costs and is used to pay for the contractors and subcontractors workers compensation, social security, Medicare, federal unemployment, state unemployment, and state training taxes. 18

29 rate; the other two were 15 percent and 38 percent of the taxable wage rate, respectively. According to the contract s General Conditions, subparagraph 6.06A.1A, the labor surcharge should be as set forth by Caltrans. During the review period, each PCO should have had a Caltrans labor surcharge of 12 to 13 percent, depending on whether regular or overtime was worked. 7 In reviewing these labor breakdowns, the audit also found that in three PCOs, PCOs 22, 121, and 151, the respective subcontractor charged more than the agreed upon labor rate. For example, PCO 121 was to furnish pipe for sleeving utilities in the walls of the tower core and shear walls. A pipefitter journeyman was charged at a lump-sum rate of $ per hour to perform work for that PCO, but the agreed upon rate provided by Hensel Phelps specified $96.40 per hour for journeyman work in this trade. Also, in PCO 151, the audit was unable to determine whether the charged rate was either over or under the agreed upon rate as the PCO did not contain sufficient detail to determine what trade the worker was working. For the two PCOs the audit was able to determine the trade of work for labor charged, PCOs 22 and 121, the Airport overpaid the subcontractors by a total of $745 and may have overpaid for others for which detailed labor breakdown documentation was not provided. Recommendations The Airport Commission should ensure all contractors, in the current contract and in all future contracts: 6. Charge the allowed Caltrans rate for the labor surcharge. 7. Are in line with the agreed-upon labor rates for each respective subcontractor. 7 The 12 to 13 percent labor surcharge rate is provided by the Labor Surcharge and Equipment Rental Rates from the California Department of Transportation, Division of Construction. The rate was effective from April 1, 2012, through March 31, 2013, the period in which the PCO work was performed. 19

30 Finding 1.3 The Airport accepted unallowable equipment charges under proposed change orders. The Airport has weak controls that caused it to pay for the rental of equipment in many PCOs that is covered in the contractor s overhead and profit. In 11 (26 percent) of 43 PCOs reviewed, job vehicles were charged as equipment used. In 5 PCOs, shores 8 were charged as equipment, costing the Airport $3,211. Also, 4 PCOs for small equipment with a fair market value of less than $1,000, such as water barriers 9, ladders, and a sprayer, were also charged for a total value of $2,592. The contract prohibits the subcontractor from separately charging for any of the above equipment. Per the contract s General Conditions, Subparagraph 6.06B.2, certain field expenses cannot be charged separately because such equipment is already covered by the 15 percent markup for overhead and profit the subcontractor receives for the PCO. The list of equipment for which rental costs are disallowed includes shores, job vehicles, and equipment with a fair market value less than $1,000. T2 Partners interpreted the General Conditions term job vehicles as vehicles solely for the purpose of transporting workers to and from the job site. According to T2 Partners, it deemed the equipment for which it paid rental costs necessary for the subcontractor to complete the work specified in the PCO. As a result, the Airport allowed the subcontractor to submit these charges. In particular, T2 Partners interpreted the terms of the contract s general conditions to mean job vehicles that were used solely to transport workers to and from the job site. According to T2 Partners, T2 Partners allowed the contractors to charge job vehicles if such vehicles were used to perform construction work. However, the audit team interprets job vehicles to include any vehicle with nonspecialized use, such as a common passenger vehicle like a Ford F-150 pick-up truck, as unallowable. Like all other previously mentioned equipment, the payment of rental costs for job vehicles is explicitly disallowed by the general conditions of the 8 Shores are used to provide a support system for trench faces used to prevent movement of soil, underground utilities, roadways, and foundations. 9 According to T2 Partners, traffic water barriers were used for this project. 20

31 contract. Also, the subcontractor receives a 15 percent markup on its direct costs, so the effect of the Airport paying unallowable costs is increased by that rate. Based on the audit s review, a list of the unallowable equipment for which the Airport paid rental costs and the total number of instances in which these payments occurred is presented in Exhibit 7. EXHIBIT 7 Source: Auditor s analysis Unallowable Equipment Charges in PCOs Reviewed Equipment Number of Reviewed PCOs With Unallowable Equipment Charges Job Vehicles 11 Shoring 5 Water Barriers 2 Sprayer 1 Ladder 2 Recommendations The Airport Commission should: 8. Ensure that unallowable charges are not charged to proposed change orders in the current contract and in all future contracts, or change the contracts General Conditions to allow for such charges, if deemed reasonable and necessary. 9. Work with the Office of the City Attorney to obtain documented clarification of the definition of job vehicles, as used in the construction contracts General Conditions, and to determine whether or not the costs to rent passenger trucks and other nonspecialized vehicles are allowable as separate costs under the contract. Finding 1.4 The subcontractor charged the Airport $1,055 for the purchase of a ladder that should neither have been purchased nor rented. The Airport allowed the misclassification of equipment in two proposed change orders. In PCO 145, which related to construction changes due to structural design changes, the Airport not only allowed the subcontractor to charge for prohibited equipment, a ladder, but the Airport allowed it to be 21

32 misclassified as materials and subsequently paid for its purchase. The subcontractor bought the ladder for $970 plus sales tax of 8.75 percent, for a total cost of $1,055. However, regardless of whether the subcontractor bought or rented the ladder, the Airport should not have paid for it. In addition to the equipment discussed in Finding 1.3, according to the contract s General Conditions, Subparagraph 6.06B.2, certain field expenses cannot be charged separately as equipment charges because such equipment is covered by the 15 percent markup for overhead and profit that the subcontractor receives for the PCO. The Airport paid for the purchase of a ladder that was apparently only used to complete the limited scope of work in the PCO. Nonetheless, the ladder should not have been charged as a purchase or an equipment rental because its fair market value is less than $1,000, as discussed in Finding 1.3. Due to this misclassification, the Airport overpaid the subcontractor $1,055. For PCO 71, which was for temporary shoring near an excavation, two pieces of equipment, a rotary hammer and a cutoff saw, were also misclassified as materials. Due to this misclassification, $14 sales tax was paid. In normal instances, sales tax is not paid on equipment, but only on materials. As such, the Airport overpaid the subcontractor for these unallowable expenses. Recommendation 10. The Airport Commission should ensure that, in the current contract and in all future contracts, all equipment, material, and labor charges by the subcontractor are classified correctly. 22

33 CHAPTER 2 The Airport Should Better Administer and Oversee the Review, Negotiation, and Approval of Proposed Change Orders Summary The Airport did not provide adequate oversight of the change management process to verify whether proposed change orders were properly reviewed, negotiated, and approved. In some PCOs the Airport did not use the required change management process and instead substantiated costs through other processes not outlined in the change management procedures. Also, the Airport and T2 Partners did not: Provide evidence of timely review of PCOs. Ensure that PCOs contained authorizations or a Finding of Fact. Further, of the proposed change order packages that contained evidence of review, many showed that the review occurred after the required response time. Finding 2.1 The Airport sometimes substantiated costs through a process other than the required change management procedures. Of the 43 PCOs reviewed by the audit, in 8 (19 percent) the Airport did not follow the change order processes required by the contract s General Conditions, Subparagraph 6.06, and the Airport s Draft Policies and Procedures. The Airport substantiated $1,033,720 in PCO costs through a process not in the change management procedures. For example, according to the Airport, PCOs 44 through 48, totaling $1,033,720 in paid exposure allowances, were paid to a subcontractor for pile foundations. These additional costs were related to an increase in the scope of work from the original bid, or a post-bid addendum. However, when the subcontractor provided an estimate for this addendum, the estimate, combined with the bid for the original scope of work, was still lower than the 23

34 original bid of the next lowest responsive bidder 10. According to the Airport, the additional work was substantiated through the competitive bidding process, which is not a process outlined in the change management procedures. However, because an exposure allowance was used and the scope of work was increased, these PCOs should have been processed and reviewed at a more detailed level through the provisions required by the Airport s policies and procedures. Not abiding by the agreed-upon contract provisions and Airport policies and procedures undermines the controls of the City and Airport management to prevent exaggerated costs from being passed through the change order process. Recommendation 11. The Airport Commission should process proposed change orders in accordance with the department s change order requirements, policies, and procedures. Finding 2.2 The Airport did not adhere to the PCO response time required by the draft policies and procedures. The Airport did not perform timely reviews of proposed change order requests. Of the 43 PCOs reviewed, 34 (79 percent) did not contain evidence of timely review by the Airport. In these cases, the Airport did not make a determination or respond to the design-builder within the required 15-day response period. As a result, the Airport increased the risk of project delays and of starting work before it was authorized or approved. According to the contract s General Conditions, Paragraph 6.03B, the City must review the PCO and its required supporting documentation within 15 days of its receipt. The Airport is required to render its determination or inform the design-builder, in writing, if more time is required. However, the 34 PCOs did not contain such a written notification that more time would be needed. 10 The City s Administrative Code, Chapter 6, Section 6.20, states that public work contracts should be awarded to the responsible bidder submitting the lowest responsive bid. 24

35 Some PCOs didn t receive a response from the Airport for up to five months. The contract goes on to state that, if the City does not issue a determination within the 15 allotted business days, the PCO would then be deemed rejected. However, in 15 instances the results of the Airport s review were communicated to the design-builder long after the 15-day requirement, but the PCO was approved. For instance, the file for PCO 151 contains a letter from the Airport to the design-builder stating that the proposed change had been reviewed and approved, but the approval letter is dated January 10, 2014, five months after the letter from the design-builder requesting the authorization. The remaining 19 PCOs did not receive a response from the Airport whatsoever. Proper and timely review of PCOs helps a project stay on schedule and mitigates the risk of performing unapproved work. Recommendations The Airport Commission should, in the current contract and in all future contracts: 12. Adhere to contract requirements by thoroughly reviewing all proposed change orders and document its written response to the designbuilder regarding the determination. 13. Perform a timely review of all proposed change orders and respond to the design-builder within the required 15-day period. If this duration is insufficient for a thorough review, Airport staff should work with the Airport Commission to agree on a longer review period and incorporate that in future contracts. Finding 2.3 More than 90 percent of PCOs reviewed had no evidence that cost negotiations were held. Proposed change order documentation did not contain evidence that cost negotiations were prepared for or held by the Airport. The Airport did not maintain proper documentation to support that cost negotiations were prepared for or held when determining the appropriate cost of a PCO. Of the 43 PCOs reviewed, 35 (81 percent) had no evidence to support that the Airport prepared for negotiations as required by the contract and 39 (91 percent) contained no evidence that cost negotiations were held. 25

36 Only five estimates were composed by the Airport in preparation for cost negotiations. According to the Airport s Design and Construction Draft Policies and Procedures, Section , Paragraph 7, the Airport, upon receipt of a cost proposal, must prepare for negotiations by completing an analysis comparing the design-builder s cost proposal against the construction manager s or project engineer s cost estimate. However, in the 43 PCOs reviewed, there was no evidence of such comparative analyses and only 5 instances (12 percent) in which T2 Partners prepared an independent cost estimate to which the contractor s proposal could be compared. According to the Airport s draft policies and procedures, as part of the cost estimate comparison, the construction manager and/or the project manager should analyze costs by evaluating the design-builder s proposed rates or unit costs of labor, material, and equipment. Preparing for negotiations by conducting an engineer s estimate allows for better understanding of the PCO and its component costs. Development of an estimate, at a minimum, provides leverage and confidence in PCO pricing negotiations and, in some instances, may lead to alternative and less costly solutions. By providing documentation, such as negotiation meeting notes, the Airport can promote and maintain transparency in its PCO process. Recommendations The Airport Commission should, in the current contract and in all future contracts: 14. Prepare for proposed change order negotiations by developing an independent estimate and preparing an analysis that compares the estimate to the design-builder s cost proposal. 15. Document all negotiations held with the designbuilder. 26