Federal Subcontracting: Further Actions Needed to Improve Oversight of Pass-through Contracts
Published: 2014-12-22T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: DOD, State, and USAID collectively spent approximately $322 billion on goods and services in fiscal year 2013. Nearly two-thirds of this dollar amount was awarded to prime contractors reportedly having a plan for using subcontractors. Concerns remain that the government could overpay contractors that provide no, or little, added value for work performed by lower-tier subcontractors. Section 802 of the NDAA for fiscal year 2013, mandated DOD, State, and USAID to issue guidance and regulations as necessary to ensure that contracting officers take additional steps prior to awarding pass-through contracts.
The accompanying conference report mandated that GAO evaluate the implementation of these requirements. This report assesses the extent to which DOD, State, and USAID issued guidance and regulations consistent with Section 802. GAO reviewed policies, guidance, and regulations at the three agencies and interviewed acquisition officials.
section_title: What GAO Found
paragraphs: Congress required the Department of Defense (DOD), the Department of State (State), and the United States Agency for International Development (USAID) to issue guidance and regulations as necessary to ensure that contracting officers complete additional analyses prior to awarding pass-through contracts—contracts meeting certain criteria and in which prime contractors plan to subcontract 70 percent or more of the total cost of work to be performed—by July 2013. (See figure.)
DOD, State, and USAID varied in their implementation of Section 802. Specifically, GAO's analysis of the agencies' policies and regulations found the following:
USAID issued a policy directive in June 2013 restating Section 802 requirements and is updating checklists used by contracting officers.
State issued a procurement bulletin in July 2014 that restated Section 802 requirements but has not taken further steps.
Neither USAID nor State has provided its contracting officers additional information to help them implement these new requirements, such as by identifying how to assess alternative contracting arrangements or how to document their decisions.
DOD has not taken any actions and is waiting for revisions to the Federal Acquisition Regulation—expected to be completed by March 2015—before deciding what, if any, changes to its guidance are needed.
As of November 2014, none of the agencies have updated their management review processes to reflect Section 802 requirements.
Federal government internal control standards state that control activities, such as policies and procedures, help to ensure that management directives are carried out and actions are taken to address risk. The lack of guidance and updated management review processes limits the agencies' ability to minimize the potential risk of paying excessive pass-through costs.
section_title: What GAO Recommends
paragraphs: To help ensure contracting officers carry out Section 802 requirements, GAO recommends that DOD, State, and USAID take two actions: issue guidance to help contracting officers perform the additional steps required, and revise management review processes and guidance to verify implementation. DOD and State agreed with GAO's recommendations but USAID did not, stating that additional guidance might limit its contracting officers' discretion. GAO maintains that both recommended actions are still warranted for USAID.

section_title: Letter
paragraphs: The Department of Defense (DOD), Department of State (State), and the  United States Agency for International Development (USAID) together  obligated approximately $322 billion on goods and services in fiscal year  2013. Of this amount, nearly two-thirds, or approximately $205 billion,  was obligated on contracts for which the prime contractor submitted a  plan to use subcontractors to meet contract requirements. GAO and DOD  audits on contracts awarded for Hurricane Katrina recovery efforts found  multiple layers of subcontractors, questionable value added by  contractors, increased costs, and lax oversight. The National Defense  Authorization Acts (NDAA) for fiscal years 2007 and 2009 contained  provisions regarding excessive “pass-through” charges to the  government. Finalized in January 2011, changes to the Federal  Acquisition Regulation (FAR) required a clause on limitations of pass- through charges in certain solicitations. This clause required prime  contractors to provide additional information to the government when they  intended to subcontract 70 percent or more of the total cost of the work to  be performed under the prime contract, including the added value they  would provide under these circumstances.
More recently, Section 802 of the NDAA for fiscal year 2013 directed the  Secretary of Defense, Secretary of State, and the Administrator of USAID  to issue guidance and regulations as may be necessary to ensure that  when an offeror notifies the contracting officer of its intent to subcontract  more than 70 percent of the total cost of the work to be performed, on  certain contracts or orders, their contracting officers must consider  alternative contracting arrangements and make a written determination  that the contracting approach selected is in the best interest of the  government prior to awarding these pass-through contracts. The  conference report that accompanied the act mandated GAO to report on  the implementation of this provision. We assessed the extent to which  DOD, State, and USAID issued guidance and regulations to address  pass-through contracting issues consistent with Section 802.
To conduct our work, we compared the provisions of Section 802 to  current DOD, State, and USAID acquisition policies, guidance, and  regulations. Specifically, we assessed whether these agencies issued  policies, guidance, and regulations to ensure that for certain solicitations  when an offeror informs the agency of its intention to award subcontracts  for more than 70 percent of the total cost of work to be performed, that  the contracting officer (1) considers the availability of alternative  contracting arrangements and the feasibility of contracting directly with a  subcontractor that will perform the bulk of the work, (2) makes a written  determination that the contracting approach selected is in the best  interest of the government, and (3) documents the basis for such a  determination. We also interviewed acquisition officials at DOD, State,  and USAID to understand the actions taken or planned to be taken and  how they intend to ensure compliance with Section 802.
We conducted this performance audit from June 2014 to December 2014  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
paragraphs: The government relies on contractors to provide a range of mission- critical support from operating information technology systems to  battlefield logistics support. Federal regulations state that prime  contractors are responsible for managing contract performance, including  planning, placing, and administering subcontracts as necessary to ensure  the lowest overall cost and technical risk to the government. Successful  offerors for contracts exceeding $650,000 that have subcontracting  possibilities are required to submit a subcontracting plan which includes,  among other things, a statement of the total dollars planned to be  subcontracted, the principal types of supplies and services to be  subcontracted, and assurances that the offeror will submit periodic  reports so that the government can determine the extent to which it has  complied with the plan.pays the contractor for allowable incurred costs, to the extent prescribed  in the contract. These costs may include the costs and fees charged to  the prime by its subcontractors. Figure 1 depicts how lower tier  subcontractor costs become part of the higher tier’s and prime  contractor’s overall costs.
section_title: Guidance for Review and Justification of Pass-through Contracts Is Incomplete and Oversight Processes Are Not Updated
paragraphs: USAID, State, and DOD varied in their implementation of Section 802.  USAID issued a policy directive that restated Section 802 requirements in  2013 and is in the process of updating various tools to assist its  contracting officers. More recently, State issued a procurement bulletin  that restated Section 802 requirements, but has not taken further steps to  update tools to assist its contracting officers. In contrast, DOD has not  taken actions, noting that the department intends to wait until a final FAR  rule is published in 2015. In general, agencies do not know the extent to  which offerors proposed to subcontract 70 percent or more of the total  cost of their contracts because agency specific and federal data systems  do not provide such information. In lieu of creating new reporting  mechanisms, each agency indicated its intent to assess contracting  officers’ implementation of Section 802 requirements using its existing  procurement management reviews. USAID has initiated revisions of  associated review guidance to incorporate these requirements, State  indicated that its current review guidance is adequate, and DOD has not  determined if changes to its guidance are necessary.
subsections: section_title: USAID and State Took Some Action to Implement Section 802, but None of the Agencies Revised Guidance or Regulations
paragraphs: USAID and State have taken some initial steps to implement Section 802,  but neither have provided contracting officers with guidance on how to  perform the required analysis of alternate acquisition approaches or  determine the feasibility of contracting directly with proposed  subcontractors, specified what documentation is necessary, or identified  where the required determination should be recorded. For example,
USAID issued a policy directive and State issued a procurement  bulletin in June 2013 and July 2014, respectively, that each restate  the requirements of Section 802. Specifically, both agencies require  that if offerors propose to award subcontracts for more than 70  percent of the total cost of work to be performed, agency contracting  officers must consider alternative contracting vehicles, make a written  determination of why the contracting approach is in the best interest of  the government, and document the basis for the determination.  USAID’s Office of Acquisition and Assistance and State’s Office of  Acquisition Management communicated the new requirement to its  acquisition community electronically and posted the policy to its  websites for future reference.
USAID and State have not issued guidance or agency-specific  regulations, however, to assist contracting officers in carrying out the  tasks required by Section 802. USAID officials noted that the agency  is currently updating checklists used by its contracting officers when  performing cost and price analysis or for drafting memoranda of  negotiation to include Section 802 requirements. They expect that  these checklists will be revised by the end of the year. USAID officials  do not anticipate the need to revise agency regulations once the FAR  is updated, noting that its contracting personnel assess proposed  contracting arrangements in accordance with the FAR as part of its  standard acquisition processes. Officials noted that the updated  checklists will remind its personnel of the Section 802 requirements to  assess the feasibility of contracting directly with proposed  subcontractors, and to document their determination that the accepted  approach is in the government’s best interests as well as the basis for  that determination. However, it is unclear if checklist revisions will  provide contracting officers with the information necessary to perform  the analysis of alternative acquisition approaches required by Section  802. State officials do not plan to update guidance to assist  contracting officers with information on how to perform the steps  required by Section 802. Similar to USAID, State officials do not  anticipate revising departmental regulations once the FAR rule is  finalized.
DOD has not issued any policies nor has it issued guidance or regulations  to implement Section 802. DOD officials explained that they are waiting  for the FAR rule expected to be issued by March 2015 and did not want to  issue policy, guidance, or regulations that may contradict the final FAR  rule. DOD officials noted that once the FAR is revised, they will consider  whether changes to DOD policy, guidance, and instruction would be  necessary.
Federal government internal control standards state that control activities,  such as policies and procedures, help to ensure that management  directives are carried out and actions are taken to address risks.
Further, government internal controls note that information should be  recorded and communicated to enable completion of internal control and  other responsibilities. The lack of additional guidance that identifies  approaches for or examples of how USAID, State, and DOD contracting  officers may assess alternative contracting approaches, to include the  feasibility of contracting directly with proposed subcontractors, or how to  document their determination that the selected approach is in the best  interests of the government may increase the departments’ risk of not  being in compliance Section 802.
section_title: Agencies Will Use Existing Mechanisms to Monitor Implementation of Section 802, but Have Not Yet Revised Applicable Processes and Guidance
paragraphs: USAID, State, and DOD officials stated that their contracting and financial  management systems do not track the subcontracting that a contractor  intends to, or has used, in performing the contracts. Further, while there  have been efforts to develop government-wide information on  subcontracting awards, these systems do not include data to identify all  levels of subcontracting. In that regard, in June 2014, we found  subcontract data contained in USASpending.gov to be unverifiable  because agencies frequently did not maintain the records necessary to  verify the information reported by the awardees.
Our analysis found that in fiscal year 2013 DOD reported obligating  approximately $129.5 billion on contracts which were of the type of  contract and dollar value that would potentially be subject to Section 802,  and that had a subcontracting plan, while USAID and State reported  obligating approximately $817 million and $222 million, respectively, for  contracts that would be subject to the criteria applicable to those  agencies. USAID, State, and DOD officials believe that few of the prime  contractors subcontract 70 percent or more of the total cost of work  performed on the types of contracts subject to Section 802. For example,  State acquisition officials believe that such a high level of subcontracting  is more likely to be found on State’s contracts for construction, which  often use fixed-priced contracts and, therefore, would not be subject to  the requirements of Section 802.
In lieu of developing new data or reporting requirements to assess  whether its acquisition personnel are properly implementing Section 802,  USAID acquisition officials noted that they will rely on routine, on-site  procurement system and contract reviews to evaluate contracting offices’  compliance with Section 802. An official from USAID’s Office of  Acquisition and Assistance, Evaluation Division stated that they  completed three procurement management reviews at international  locations in October 2014 during which pass-through contracts were  discussed, but were not found to be an issue. USAID officials noted that  they intend to revise their guidance governing procurement system  reviews by the end of 2014. Similarly, both State and DOD officials  indicated that they intend to rely on procurement management reviews to  determine if contracting officers are properly implementing Section 802,  but noted that associated review guidance has not been updated. At the  same time, our review of current USAID, State, and DOD procurement  management review instructions and checklists found that they do not  reflect all Section 802 requirements. State officials believe that pass- through contracting issues will be addressed because its officials use the  department’s domestic contract file table of contents as a checklist, which  includes sections on solicitation and pre-award documentation, to conduct  contract file reviews. State does not currently plan to revise the guidance  to specifically reflect Section 802 requirements. DOD acquisition officials  noted that they have not yet determined what changes to guidance, if  any, would be required.
GAO/AIMD-00-21.3.1. specifically incorporating these requirements into review guidance,  agencies may not effectively oversee compliance.
section_title: Conclusions
paragraphs: Over the past 8 years, a number of legislative and regulatory changes  have been enacted to enhance the government’s insight into the billions  of dollars that prime contractors award to subcontractors. Initially, the  focus of these changes had been on requiring prime contractors to notify  contracting officers when they intend to rely largely on subcontractors.  Section 802 changed that paradigm by requiring contracting officers to  consider alternative arrangements, such as directly contracting with  subcontractors and to make a written determination that the accepted  approach is in the best interest of the government, and to document the  basis for such a determination when they receive such a notification.  Neither USAID nor State has provided its contracting officers additional  guidance to help them implement these new requirements. DOD, having  the highest level of obligations for contracts that may be potentially  subject to Section 802 requirements, has not taken any actions and is  waiting for the issuance of a final FAR rule before deciding what, if any,  revisions to its guidance are needed. USAID, State, and DOD intend to  use procurement management reviews to monitor implementation of  Section 802, but have not updated the related review processes and  guidance. Without data on the extent to which agencies make use of  contracts that rely largely on subcontractors, it is essential that agencies  provide guidance to assist their contracting officers in implementing  legislative requirements and develop oversight processes to assess their  agencies’ compliance. DOD’s decision to wait until the FAR is revised  next year rather than proactively initiating actions has increased the risk  that its contracting personnel are not currently acting in compliance with  the law and may also have missed opportunities to establish more  beneficial contracting arrangements. While State and USAID obligate less  for contracts that may be subject to Section 802, their more limited  exposure does not obviate the need to provide guidance or management  oversight. Federal internal control standards highlight the need for  agencies to establish processes and procedures to ensure compliance  with statutory provisions.
section_title: Recommendations for Executive Action
paragraphs: We recommend that the Secretary of Defense, Secretary of State, and  Administrator of USAID take the following two actions to help ensure  contracting officers carry out the requirements of Section 802:  issue guidance to assist contracting officers by identifying approaches  for or examples of how to assess alternative contracting approaches  to include the feasibility of contracting directly with proposed  subcontractors, and documenting a determination that the approach  selected is in the best interests of the government; and  revise the processes and guidance governing management reviews of  procurements to ensure that such reviews assess whether contracting  officers are complying with the provisions of Section 802.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to DOD, State, and USAID for  comment. DOD and State concurred with our recommendations, but  USAID did not agree that additional guidance was necessary to assist  contracting officers when assessing alternative contracting approaches  and noted current management reviews would be used to identify  subcontracting issues. The agencies’ comments are summarized below.  Written comments from DOD, State, and USAID are reproduced in  appendixes II, III, and IV respectively.
In response to the recommendation to identify approaches for, or  examples of, how to assess alternative contracting approaches, and  document a determination that the approach selected is in the best  interests of the government, DOD and State concurred. DOD, by way of  explaining its delay in issuing guidance, noted it was required to adhere to  the regulatory rulemaking process and noted that the final FAR rule to  implement Section 802 is expected to be issued in March 2015. Section  802 provided flexibility for DOD to issue guidance and regulations as may  be necessary to ensure contracting officers take specific actions for  certain solicitations and we continue to believe DOD should do so  expeditiously. State noted that it will issue guidance to assist contracting  officer to assess alternative contracting approaches and document the  determination that the approach selected is in the best interest of the  government. USAID did not believe it was necessary to issue additional  guidance, stating that the FAR has provided specific actions for a  contracting officer to follow to ensure that they identify and adequately  reconsider proposed contracts and that to provide additional guidance  may limit its contracting officers’ discretion. As we noted in the report,  USAID has restated these actions in a policy directive, but it has not  provided contracting officers with guidance on how to perform these new  requirements. Specifically, USAID has not provided examples of how to  conduct an analysis of alternate acquisition approaches or determine the  feasibility of contracting directly with proposed subcontractors, described  what documentation is necessary, or identified where the required  contracting officer’s determination should be recorded. Rather than limit a  contracting officer’s discretion, we believe that more specific guidance will  help contracting officer’s comply with these new requirements, improve  oversight, and align more closely with federal internal control standards.
DOD and State concurred with our recommendation to revise their  processes and guidance governing management reviews of  procurements to ensure that such reviews assess whether contracting  officers are complying with the provisions of Section 802. DOD indicated  it will provide or revise and update guidance governing management  reviews to ensure that such reviews assess whether contracting officers  are complying with the provisions of Section 802. In addition, once the  final FAR rule is issued, DOD noted it will assess whether it needs to  include supplemental information in its Procedures, Guidance, and  Information to ensure compliance. State noted that it will also revise its  management review guidance to include compliance with Section 802.  USAID did not specifically state whether it concurred with the  recommendation, noting that it will be reviewing random files during  procurement system reviews to see if contracting officers are taking  appropriate steps in instances where an offeror proposes to award  subcontracts for more than 70 percent of the total award. We agree that  such an approach could be an appropriate step when conducting a  procurement management review, but, as noted in the report, USAID has  not revised the processes and guidance governing management reviews  of procurements to do so. Federal internal control standards state that  guidance helps to ensure that management directives are carried out and  actions are taken to address risks and, accordingly, we continue to  believe that USAID should revise its procurement management guidance.
We are sending copies of this report to the appropriate congressional  committees, the Secretary of Defense, the Secretary of State, and the  Administrator, USAID, and other interested parties. In addition, the report  is available at no charge on the GAO website at http://www.gao.gov.
If you or your staff have any questions about this report, please contact  me at (202) 512-4841 or DinapoliT@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on  the last page of this report. GAO staff who made key contributions to this  report are listed in appendix V.
section_title: Appendix I: Scope and Methodology
paragraphs: Section 802 of the National Defense Authorization Act (NDAA) for Fiscal  Year 2013 directed the Secretary of Defense, Secretary of State, and the  Administrator of the United States Agency for International Development  (USAID) to issue guidance and regulations as may be necessary to  ensure that when an offeror notifies the contracting officer of its intent to  subcontract more than 70 percent of the total cost of the work to be  performed on certain contracts or orders, contracting officers consider  alternative contracting arrangements and make a written determination  that the contracting approach selected is in the best interest of the  government and document the basis for the determination. The  conference report that accompanied the act mandated GAO to report on  the implementation of this provision. We assessed the extent to which  the Department of Defense (DOD), Department of State (State), and  USAID revised their guidance and regulations to address pass-through  contracting issues consistent with Section 802.
To conduct our work, we compared the provisions of Section 802 to  current DOD, State and USAID acquisition policies, guidance, and  regulations. Specifically, we assessed whether these agencies issued  policies, guidance, and regulations to ensure for certain solicitations when  an offeror informs the agency of its intention to award subcontracts for  more than 70 percent of the total cost of work to be performed that the  contracting officer (1) considers the availability of alternative contracting  arrangements and the feasibility of contracting directly with a  subcontractor that will perform the bulk of the work, (2) makes a written  determination that the contracting approach selected is in the best  interest of the government, and (3) documents the basis for such  determination. We interviewed acquisition officials at DOD’s Office of  Defense Procurement and Acquisition Policy, the military departments,  Defense Contract Management Agency (DCMA), and Defense Contract  Audit Agency (DCAA); State’s Offices of Acquisition Management and  Office of the Procurement Executive; and USAID’s Office of Acquisitions  and Assistance in Washington, D.C. and Kabul, Afghanistan, to  understand the steps taken and future plans for completing the required  guidance and regulation. We also interviewed Federal Acquisition  Regulation Council representatives to understand content and timeframes  for a government-wide regulation being developed in response to the  Section 802 statutory requirements.
To determine how agencies identify or monitor pass-through contracts,  we interviewed acquisition officials at DOD, State, and USAID and  reviewed guidance available to contracting officers and supporting  agencies, such as DCAA and DCMA. We used the government’s  procurement database—Federal Procurement Data System-Next  Generation (FPDS-NG)—to identify DOD, State, and USAID total  obligations for fiscal year 2013 on contracts that by type and value could  be subject to Section 802 requirements and reported having a plan to use  subcontractors. For DOD, these are contracts where obligations exceed  $700,000 and exclude certain fixed-price contracts. For State and USAID,  contracts include those where obligations exceeded $150,000 and are  cost-type contracts. To assess the reliability of FPDS-NG’s data, we (1)  performed electronic testing for obvious errors in accuracy and  completeness; and (2) reviewed related documentation. We found the  prime contract obligation data sufficiently reliable for the purposes of this  report. We were unable to use subaward information in  USASpending.gov to reliably identify whether these obligations were  made to contractors whose subcontracting costs comprised over 70  percent of the total costs of the contract. As noted in our June 2014  report, federal reporting systems used to populate USASpending.gov do  not identify all contract awards and that the information is largely  inconsistent with agency records or unverifiable.
We conducted this performance audit from June 2014 to December 2014  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
section_title: Appendix II: Comments from the Department of Defense
section_title: Appendix III: Comments from Department of State
section_title: Appendix IV: Comments from the United States Agency for International Development
section_title: Appendix V: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Penny Berrier (Assistant  Director), Marycella Cortes, Thomas Twambly, Julia Kennon, Alyssa  Weir, Danielle Greene, and Jena Sinkfield made key contributions to this  report.