Monitoring Legal Updates and Emerging Cases Impacting the ... · Agenda •Statute of Limitations •Access to Employees ... •DCAA issued report in 2005 (given to another DCAA office,

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5th DCAA & DCMA Audit & Compliance Boot Camp

Dave Nadler Partner and Government Contracts

Practice Group Leader Dickstein Shapiro LLP

@GovConDS

Monitoring Legal Updates and Emerging Cases Impacting the False Claims Act and Statute of

Limitations for Government Contracts

J.B. Perrine Senior Counsel

Huntington Ingalls Industries, Inc.

July 21-23, 2015

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Agenda

• Statute of Limitations

• Access to Employees

• Attorney-Client Privilege

• Mandatory Disclosure Rule

• DCAA Fraud Referrals

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STATUTE OF LIMITATIONS

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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

• At the end of FY 2014, DCAA had a backlog of 11,324 ICS currently on hand, with another 6,861 ICS for which it was awaiting receipt and/or awaiting an adequacy determination

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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 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

Laguna Construction Co., Inc. (ASBCA, 5/29/14) Government claim for $3.8 million in subcontract costs time-barred

• Laguna awarded task orders in 2004-2005; subcontract pricing incorporated into task orders at that time

• DCAA conducted an audit in 2005 and found Laguna’s subcontract management system to be inadequate – could not determine whether subcontract pricing was fair and reasonable

• DCAA issued report in 2005 (given to another DCAA office, but not the ACO)

• DCAA issued a report to the ACO in 2006 6

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Laguna Construction Co., Inc. (ASBCA, 5/29/14)

• In March 2011, the ACO sent a notice disapproving subcontract costs based on DCAA’s findings, but did not issue a final decision until December 2012

• ASBCA found claim to be time-barred based upon government’s knowledge of claim from the 2006 audit report that was given to ACO, which documented these findings

• Unclear whether the 2005 audit report would have been sufficient to trigger claim accrual, even though it was not given to the ACO

• The Board acknowledged that the government was aware of basis of claim in 2005, but only relied on the 2006 report in its holding

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

• Raytheon submitted final indirect cost rate proposals setting forth new compensation practices in 2003

• DCAA issued memorandum in September 2003 (prior to initiation of audit) indicating that it viewed the compensation costs as fully allowable

• DCAA informed Raytheon that it viewed the costs as unallowable in 2006, and ultimately issued an audit report with this finding in 2007 (and assessed penalties for Raytheon’s failure to withdraw the costs)

• Government did not issue a final decision until January 2011 8

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Raytheon Co. (ASBCA, 12/17/12)

• The ASBCA found the 2011 claim time-barred; focused on submission of ICS, rather than date of audit

• Found that the initial DCAA memorandum in 2003 indicated that the Government knew the facts necessary to assert its claim

• Memo was written prior to initiation of audit

• DCAA had not yet concluded that the compensation practices were improper, and in fact, did not do so until several years later

• Indicates that cost submission or forward pricing rate proposal may start the clock for claim accrual purposes

• DCAA knowledge of facts can be imputed to entire Government – don’t need to rely on CO knowledge 9

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

• In October 2000, Boeing submitted a CAS Disclosure Statement providing notice regarding revised accounting practices relating to 1997 merger

• DCAA issued audit report regarding cost impact in June 2002, and in September 2003, notified Boeing that the change was undesirable and Boeing would be liable for cost increases

• The parties conducted intermittent negotiations from 2005-2010, and the government issued a final decision demanding $6.4M in October 2010

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Boeing Co. (ASBCA, 1/6/12)

• ASBCA found that the claim was time-barred because it accrued “at the latest” in 2003 when the CO wrote the letter stating that the costs were undesirable and that Boeing would be liable for cost increases

• The government did not dispute that the claim accrued at this time, but instead argued that the statute of limitations should be tolled

• The government accused Boeing of leading the CO to believe that the contract adjustment issue was “on the verge of settling” many times during the five years in which negotiations were conducted

• Argued that Boeing’s actions induced the CO to let the limitations period run

• The ASBCA rejected this argument because it found that Boeing’s unexpected disagreement did not show that it induced or tricked the government

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KBR (ASBCA, 6/17/14) Board dismissed Government’s claim for $56 million as untimely

• Claim related to KBR’s use of private security companies (PSCs) to provide protection for its personnel and subcontractor personnel in Iraq

• The claim was not issued until January 2013, even though the Government had knowledge at various points over the years, including as early as 2004, that KBR was using PSCs

• For example, various personnel, including the DCMA Commander in Iraq, had knowledge of these practices in 2004-2005

• In June 2005, the Government was expressly advised that PSCs were being used to transport personnel in Iraq

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KBR (ASBCA, 6/17/14)

• The Board ultimately found that the claim accrued “no later than” June 10, 2005

• At that time, the Government had express knowledge that KBR was using the allegedly prohibited private security companies to transport personnel

• The decision suggests that knowledge by various individuals of the use of PSCs prior to June 2005 likely also would have been viewed as sufficient for claim accrual

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Impact of These Decisions

• These and other contractor-friendly decisions have led DCAA to speed up audits, since submissions to DCAA can trigger claim accrual

• Increase in issuance of qualified reports

• DCAA may not issue draft reports or may significantly reduce time for contractor comments on draft reports

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

• In some cases, COs have only a matter of days to issue a decision before the statute runs

• Less negotiation with CO before issuing formal claim = more litigation 14

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The Sikorsky Decision

Sikorsky Aircraft Corp. v. United States (Federal Circuit, 2014) found that the CDA’s statute of limitations is “no longer a jurisdictional issue”

• Instead, statute of limitations issues may now be raised as an affirmative defense

• Shifts burden to party defending against a claim

• As an affirmative defense, SOL issues must now be raised in defendant’s initial pleading or else they will be deemed waived

• Creates a new opportunity for parties to use tolling agreements to suspend the statute of limitations, since no longer a jurisdictional matter

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Coherent Logix (ASBCA, Apr. 2015) First case to treat statute of limitations as an affirmative defense pursuant to Sikorsky Aircraft

• Coherent submitted a final indirect rate proposal in 2008, but the line item for “Legal Fees” did not contain sufficient detail to put government on notice of potential claim regarding unallowable patent legal fees

• The ASBCA found that only when more detail was provided in 2013 did the claim accrue

• Applying Sikorsky, the ASBCA found that Coherent failed to prove that government’s claim for overpayment accrued more than six years prior to CO’s final decision

• As an affirmative defense, burden was on Coherent to make this showing

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Best Practices

• Take action to ensure a strong 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

• Line items with no detail may be insufficient to put government on notice of potential claim (Coherent Logix)

• 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 17

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Best Practices

• Raise statute of limitations as an affirmative defense against government claims in initial pleading to avoid waiver

• Burden will be on the contractor to demonstrate that claim accrued more than 6 years before assertion of claim where contractor is defending against a government claim

• Consider tolling agreements to suspend statute of limitations

• With the Sikorsky decision, contractors can now use tolling agreements where the CO would have otherwise been required to issue a claim

• Provides a mechanism to avoid premature/prophylactic final decisions

• Many issues may be ripe for settlement, and thus, tolling agreements allow the parties to avoid unnecessary litigation

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ACCESS TO EMPLOYEES

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Access to Employees

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 20

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Access to Employees

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

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Access to Employees

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

This is a role more appropriate for trained investigators, rather than auditors 22

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Access to Employees

• 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

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Access to Employees

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”

• A contractor’s refusal to provide DCAA access to its employees could be deemed a denial of access and result in a significant deficiency finding

• DCAA’s position appears to conflict with Newport News decisions, which held that DCAA is not entitled to contractor’s subjective materials, findings, or conclusions

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Practical Considerations

• Given the inherently subjective nature of fraud, interviews could deviate from the objective facts that auditors are supposed to gather and corroborate

• Auditors may collect and review subjective assessments and opinions 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 25

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Practical Considerations

• 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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Best Practices

• Establish clear boundaries for any interviews

• Interviews should discuss facts pertaining to cost practices and creation/maintenance of records, not subjective opinions/conclusions

• Provide an appropriate management point of contact for DCAA inquiries and direct all inquiries to that person

• Individual should be capable of providing fact-based responses regarding the systems under review

• Remember that a refusal to provide access to employees may be deemed a deficiency 27

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Best Practices

• Ask for interview topics in advance of interviews

• Ensure that appropriate employees with knowledge of relevant facts are available to answer questions

• Inform DCAA of the scope of responsibilities for these employees and explain that detection and mitigation of potential fraud does not fall within their responsibilities

• Employees should be instructed that their role is to answer questions about the contractor’s “records” – i.e., how/when the records were created, what particular entries mean, whether additional records or policies exist, etc.

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Best Practices

• Ask for an opportunity to address any auditor concerns arising from an interview

• Many concerns will likely relate to ordinary cost issues (e.g., insufficient documentation) that the particular employee was unable to address

• Contractors should also be prepared to discuss any concerns about potential fraud that the auditor may have and provide a full explanation of the facts to ensure that the auditor has a complete picture

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ATTORNEY-CLIENT PRIVILEGE

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Attorney-Client Privilege

In re: Kellogg Brown & Root, Inc. (appeal of U.S. ex rel. Barko v. Halliburton)

• Qui tam suit alleging that KBR overcharged the Government under LOGCAP III contract

• D.C. District Court held that internal investigation reports of alleged misconduct were not privileged because the documents were created for a “business purpose” – i.e., complying with the Mandatory Disclosure Rule

• D.C. Circuit overturned the D.C. District Court and found that the reports were protected by the attorney-client privilege

• Privilege applies whenever obtaining legal advice is a significant purpose of the investigation – “even if there were also other purposes” and “even if the investigation was mandated by regulation” 31

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Risk Mitigation

• Ensure that counsel is actively participating in the investigation

• Although use of outside counsel and “magic words” (i.e., Upjohn warnings) are not required, use them anyway

• Ensure that internal policies make clear that the purpose of the internal investigation is to seek or provide legal advice

• Ensure that it is clear that the investigation is being directed by counsel who will be evaluating the results of the investigation and will draft any findings 32

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Risk Mitigation (continued)

• Ensure that internal investigation reports and audits are only addressed to their intended audience (e.g., management personnel) and that they are marked as privileged and confidential

• Ensure that employees understand the importance of protecting the privilege and do not forward reports internally beyond the intended audience

• Consider privilege implications before providing documents to other entities, such as DCAA, and assert the privilege where appropriate 33

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FAR MANDATORY DISCLOSURE RULE

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Mandatory Disclosure Rule

• The Mandatory Disclosure Rule requires contractors to “timely disclose” “credible evidence” of certain criminal laws (i.e., conflict of interest; bribery; gratuities), civil false claims and “significant overpayments” that are “in connection with the award, performance, or close-out of a Government contract or subcontract”

• “Timely” and “credible evidence” are not defined

• “Significant” is not defined

• “Reverse false claims” – knowing and improper retention of an overpayment can subject company to False Claims Act liability

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Risks of Not Disclosing

• Increased Exposure under the False Claims Act (FCA)

• Failure to disclose removes statutory mitigation under the FCA

• Reduced Damages – only available if “all information known” about the violation is provided to the government within 30 days of learning about the violation (31 U.S.C. Section 3729(a)(2))

• Reduced damages provision allows for double damages rather than the treble damages otherwise allowed by the FCA

• Increases the likelihood of a criminal prosecution against the Company as distinguished from criminal prosecution of individuals

• Increases risk of suspension or debarment of the Company for not being “presently responsible”

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DCAA’s Role with the FAR MDR

• DCAA audits, among other things, the amounts defense contractors should be reimbursed for administering their compliance programs

• DCAA has issued guidance to its auditors regarding how to assess contractor compliance with the Mandatory Disclosure Rule, which has been incorporated into the DCAA Contract Audit Manual (DCAM)

• DCAM Section 5-300, Audit of Internal Controls – Control Environment and Overall Accounting System Controls

• DCAM Section 5-306, Integrity and Ethical Values

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DCAA’s Role: Code of Ethics

• DCAM 5-306.1 Codes of Business Ethics and Conduct: FAR does not detail specific areas to be covered, but contractor’s code of conduct should address ethical business practices and expected standards of ethical behavior, and dealings with customers, suppliers, employees, and other parties

• DCAA evaluates adequacy of a contractor’s written code of conduct:

• Codes should address conflicts of interest, illegal or other improper payments, anticompetitive guidelines, and insider trading

• Codes should cover compliance with Government contracting requirements regarding procurement integrity, handling of classified information, and recruiting and employing current or former Government personnel

• Codes are periodically acknowledged by all employees

• Codes clearly establish what behavior is acceptable or unacceptable, and what to do if employees encounter improper behavior

• Codes cite consequences for violations 38

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• DCAM 5-306.3: Business Ethics Awareness and Compliance Internal Control System and minimum requirements for compliance with FAR 52.203-13(c)(2)(ii)

• Assignment of responsibility at a sufficiently high level to ensure the effectiveness of the business ethics awareness and compliance program and internal control system

• Procedures to ensure individuals who previously engaged in conduct that conflicts with the contractor’s code of conduct are not appointed as a principal of the company (e.g., officer, director, partner)

• Periodic evaluations (i.e., at least annually) of the effectiveness of the business ethics and awareness compliance program and internal control system

• Disciplinary action for improper conduct, or failing to take reasonable steps to detect improper conduct

• An internal reporting mechanism, such as a hotline, by which employees may anonymously or confidentially report suspected instances of improper conduct, and instructions that encourage employees to make such reports

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• Auditors should ensure that the contractor’s policies and procedures include a reasonable definition of credible evidence, and a reasonable timeframe for disclosure once credible evidence is obtained

• Contractors are allowed to take time for preliminary examination of the evidence to determine its credibility prior to disclosure

• Full cooperation with any Government agencies responsible for audits, investigations, or corrective actions

• If there are known cases where the contractor has not cooperated with audits or investigations, the contractor can be cited for deficiency relating to its control environment

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• Auditors will confirm that there are no outstanding access to records issues

• DCAA auditors are to review any disclosures reported to the OIG and CO and ascertain if the contractor has taken the necessary corrective actions to protect the Government’s interests

• If the contractor has not taken the appropriate corrective action, the auditor should report this as an internal control deficiency

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DCAA’s Role: Restitution

• Though the MDR was designed to encourage contractors to implement robust, effective compliance programs and to report non-compliances, the program is also focused on restitution

• The MDR prototype process envisions a process under which a contractor submitting a disclosure quantifies a possible restitution amount, which Government auditors test via audit techniques

• Contractors complain that DCAA auditors do not test the quantification the contractor has provided, but instead develop their own quantification using different assumptions, parameters and techniques that fundamentally change the nature of the contractor’s disclosure and quantification

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DCAA’s Role: Restitution

• DCAA auditors respond that they had to create their own quantification structure and approach because the contractor’s approach was not sound from an auditing standpoint or did not provide sufficient detail or support to allow testing or confirmation

• Before closing a disclosure, IGs obtain sign-off from the significant stakeholders, including DCAA, the applicable SDO, DOJ representatives, and the CO

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DCAA FRAUD REFERRALS

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• An increasing number of FCA cases are being initiated after referrals from DCAA to the DoD IG based on DCAA’s application of Fraud Indicators during routine audits

• DCAA’s Contract Audit Fraud Scenarios

• Review of professional/consultant services

• Subcontractor/vendor kickbacks

• Adjusting journal entries-labor transfers

• Direct and indirect labor

• Expressly unallowable costs

• Material transfers

• Forward pricing proposal – labor categories

• Improper billing of costs on progress payments

DCAA Fraud Referrals

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• Each scenario contains specific Fraud Indicators, many of which are undefined and generic

• “Inadequate or weak controls”

• “Overly complex organizational structure”

• “Missing electronic or hard copy documents”

• “Photocopied documents instead of originals. Copies are poor quality or illegible”

• “Lengthy unexplained delays in producing requested documentation”

• “High turnover of senior executives or managers”

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

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• 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

• No criteria exist for when an auditor should make a fraud referral

• 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

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Risk Mitigation

• Expect auditors to question any irregularities as a possible Fraud Indicator, even in the absence of evidence of any fraudulent activity

• 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

• Ensure that compliance with the mandatory disclosure rule is consistent with any internal policies

• 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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Documents

Monitoring Legal Updates and Emerging Cases Impacting the ... · Agenda •Statute of Limitations •Access to Employees ... •DCAA issued report in 2005 (given to another DCAA office,