The Department of Defense Office of Inspector General (“DoD IG”) appears poised to place new emphasis on the pursuit of fraud cases in certain key enforcement areas, at least according to updated agency guidance recently published online. Earlier this month, the DoD IG quietly revised its “Auditor Fraud Resources” page, intended to serve as guidance for DCAA auditors, by adding new materials addressing fraud scenarios in the context of defective pricing and forward pricing proposal audits. Although the appearance of this new guidance was the cause of little fanfare, the prospect of increased enforcement activity in these areas could significantly impact the defense contracting community.

DoD IG Guidance: Audit Scenarios & Fraud Indicators

The Inspector General Act of 1978 requires the DoD IG to “provide policy direction for audits and investigations relating to fraud, waste, and abuse.” In fulfillment of this duty, the DoD IG maintains an online “Auditor Fraud Resources” repository, which contains guidance and information designed to “increase an auditor’s awareness of possible risk factors” in common audit scenarios. Within these resources is a separate page, the “Contract Audit Fraud Scenarios and Resources” page, devoted specifically to government contracts audit scenarios and related “fraud indicators.” DCAA auditors are instructed to “familiarize themselves with the basic knowledge provided by the scenarios [and fraud indicators]” and to “creatively use it while performing any audit or review.” As such, these online resources not only serve an internal agency training function, but also often foreshadow shifts in audit priorities. Moreover, when DCAA auditors discover an indication of potential fraud, DoD Instruction 7600.02 (Audit Policies) directs them to refer the issue to the appropriate investigative agency. Thus, defense contractors are well-advised to review this guidance and keep apprised of changes like those discussed below.

Defective Pricing Audits

As noted, the DoD IG recently added two new audit scenarios to its Auditor Fraud Resources page. In the first scenario, auditors initiated a post-award defective pricing audit following a contractor’s completion of a firm-fixed priced contract. The contract price had been negotiated at the time of award based on cost or pricing data provided in the contractor’s proposal. Upon contract completion, however, it was determined that the contractor’s actual incurred costs for parts and other materials were significantly less than those reflected in the proposal’s pricing data. The auditors determined that this cost underrun was due to two factors: (1) for certain parts, the contractor had obtained (and provided to the government) price quotes from one vendor, only to subsequently purchase parts from a different vendor at a lower price; and (2) for other parts, the contractor had obtained (and provided to the government) an initial or budgetary quote from a vendor, only to subsequently negotiate a lower firm quote after contract award. The audit team therefore determined that the contractor’s cost or pricing data was not TINA-compliant (i.e., current, accurate, and complete), and that the materials had been defectively priced. Accordingly, the auditors calculated a commensurate price adjustment and referred the matter to DoD criminal investigators for further action.

Following this hypothetical scenario is a list of “fraud indicators” related to defective pricing. These indicators of defective pricing include “a significant variance between proposed and negotiated vendor prices”; “use of different vendors or subcontractors than proposed”; and “using higher budgetary/planning quotes to support proposal knowing that lower firm quotes have been or will be submitted on request.” Of equal interest, however, are three areas in the accompanying discussion regarding the application of these fraud indicators.

First, the guidance warns auditors to be especially vigilant “in contracts for major weapon systems with extensive bills of material and/or complex, multiple subcontracting tiers,” ensuring that these programs will likely see added scrutiny. Second, the guidance includes the following startling pronouncement: “The main difference between defective pricing and potential fraud include the root cause of the underrun and the contractor’s intent. Since the auditor does not prove intent, the circumstances leading to defective pricing generally warrant a fraud referral.” Stated differently, auditors are expected to refer an item if the fraud indicators are present, regardless whether there is any actual evidence of criminal intent. Third, the guidance notes that auditors should consider potential fraud indicators beyond the contractor’s actions at award, to include how the contractor responded to questions raised during the audit. For example, among the fraud indicators in this area are denials by contractor employees of the existence of historical or other records that are later found in the audit. Contractors need to be vigilant from the start of the audit to provide appropriate cooperation in order to avoid an adverse finding based solely on conduct during the audit.

Forward Pricing Rate Proposal Audits and Falsified Documents

The second new audit scenario, focusing on the falsification of documents in the forward pricing proposal context, involves an audit of a contractor’s forward pricing rate proposal (FPRP) that reflected substantial facility rental costs. In this situation, the contractor could not provide documentation to support these rental costs (e.g., lease agreements, accounts payable records, etc.) in a timely manner. The auditors eventually obtained the lease files from the contractor’s leasing management company, whereupon they discovered that the contractor’s actual rental costs were significantly lower than those claimed in the FPRP. Shortly thereafter, the contractor provided the auditors with a lease agreement and rental invoices that looked similar to those obtained from the leasing company, but that appeared to have been altered to reflect higher rental amounts. In light of this apparent falsification of records, the audit team referred the matter to a DoD criminal investigator for further action.

Following this audit scenario is another list of “fraud indicators,” this time concerning falsified documents. Some of these indicators are fairly intuitive (e.g., “supporting documentation . . . does not match information obtained from third party sources”; “illegible copies of supporting documentation”; “changes to the original documentation that do not appear to be authentic”), but others are less obvious. For instance, one of the listed indicators of falsified documents is “[u]nreasonable delays in providing supporting documentation that should be readily available.” Of course, the DCAA’s perception of what should be “readily available” does not always align with contracting reality. Still, given that DCAA categorizes delays in producing documentation as a “fraud indicator” is a useful reminder of the importance of providing supporting documentation on a timely basis, as well as the need to communicate proactively when it appears that more time may be needed.