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Friday, December 30, 2011

The limits of procurement law

"If you only have a hammer, you tend to see every problem as a nail."
Abraham Maslow


This post concerns a controversy over the allocation of Low Income Housing Tax Credits ("LIHTCs"), specifically whether that controversy is cognizable under the procurement law. The basics of the story are reported in this online news item:

VIDEO: OPA Confirms Protest Halts GHURA Tax Credit Award; Cruz Concerned About Conflict of Interest.

The same news source, Pacificnewscenter.com, has a copy of the protest filed at http://www.pacificnewscenter.com/images/pdf/medallionprotestletter.pdf.

The article quotes the Guam Public Auditor as saying, "The form of tax credits is really a form of payment which is after the fact after a procurement has been made so the process is still a procurement issue”. As a consequence of the procurement characterization, she indicated that an automatic stay has been placed on the allocation of tax credits.

I want to speak to one element of the controversy, the procurement angle.

First, my disclosure. I am General Counsel for Jones & Guerrero Co., Inc., which is one of the principles behind the GREAT Homes, LLC, LIHTC application. I have not had much to do with this project, however, since specialized and experienced consultants and advisors have been retained to assist the application package. I am aware that the applicant has spent considerable time and money in the application process, however, my knowledge of the LIHTC program in general is rudimentary and I have had no direct participation in the planning or completion of this particular project application.

As reported in the media, Medallion Guam, LLC, has “protested” GHURA’s allocation of LIHTCs. Its attorneys, and others who should know better, have made the unsubstantiated claim that the allocation process is subject to the Procurement Act. I disagree, but, unlike the persons claiming such coverage, I will specifically detail why.

The Federal government has seen fit to grant federal income tax concessions to developers of certain low income housing developments to encourage such developments when profit is insufficient to the task. In no way does the procurement law apply to the process of qualifying for income tax breaks. That is a matter of tax law, US tax law.

If there is a dispute over the amount, timing or eligibility of the use of a tax credit, is that determined under the procurement code (see, 5 GCA § 5427 re contract controversies), or is it determined by the taxing authorities under the tax laws? It is a tax matter, not a procurement matter.

The procurement act applies to “procurement”, defined as “buying, purchasing, renting, leasing or otherwise acquiring any supplies, services or construction” (5 GCA § 5030(o)). The Government of Guam does not “acquire” anything under the LIHTC program. The project is designed, built, owned and managed by the developer. It is never bought, purchased, rented, leased or acquired by GovGuam.

The protest letter claims the procurement act is applicable because “[t]he Guam Procurement Code is meant to be construed broadly and cover territorial acts that include "federal assistance." 5 GCA §5004(b ).” This is not quite even half a truth. Yes, the procurement code is meant to be construed broadly, but only “to promote its underlying purposes and policies” (5 GCA § 5001(a)), and low income housing policy is not one of its purposes or policies. Yes, the procurement code does “cover” certain federal assistance, but it does not cover all “territorial acts”; it only covers certain local government “contracts”.

And it is at this point that the protest artfully fails to describe the whole truth, which contracts are covered by the procurement law? The unmentioned part of 5 GCA 5004(b) states, the procurement law “shall apply to every expenditure of public funds ... under any contract....” The scope of the procurement law is limited to expenditures of public funds under contract.

The award of tax credits is not an “expenditure”, and tax credits are not “public funds” (and it can be noted, the Public Auditor’s duty and authority extends to settling “the accounts of Disbursing Officers and Certifying Officers”, but “[t]his authority shall not extend to the collection of income taxes....” (1 GCA § 1909(b)).

Procurement law does not define what is meant by the term “expenditure” (in the phrase “expenditure of public funds”), but the funds management provisions of Guam law do. “Expenditures means all amounts of money, other than refunds authorized by law, paid out or encumbered for payment by a Territorial agency other than for investment securities or as agent or trustee for other governmental entities or private persons.” (5 GCA § 4117(g).)

Tax credits are not money. They are not the functional equivalent of money; you cannot pay your dinner tab with a tax credit. Tax credits are not money paid out by the government. They are conditional offsets of tax liabilities owed by a taxpayer to the government.

Likewise, the term “public funds” (in the phrase “expenditure of public funds”) is not defined in the procurement law, but it is a term used in the fiscal management provisions of Guam law.

14 GCA 14104(c) says, “ 'Fund' shall mean as used in this Chapter the General Fund and all special and trust funds. This includes impress fund cash held at personal risk.” Fund would not include tax credits.

14 GCA § 14105 says of “public funds”, “All public funds of the government of Guam shall not be disbursed, except ... by the persons designated or delegated....” This again speaks to the notion that public funds are amounts paid out by the Government. Tax credits are not public funds to be disbursed, paid or expended by the persons charged with the care and accounting of government money, as more fully detailed in Chapter 14, Title 4, GCA.

The expenditure of public funds must begin with budgets and approvals. The Governor must prepare “a financial plan which shall cover estimated receipts ... and expenditures of the government of Guam for the General Fund and all special funds....” (5 GCA § 4103.) 5 GCA § 4107(b)(4) requires the Governor to annually “present the proposed comprehensive program and financial plan “, to include a “summary of expenditures during the last fiscal year, those estimated for the current fiscal year and those recommended by the Governor for the succeeding fiscal year....”

Neither these plans nor reports discuss tax credits allowed under the tax laws, even though such credits do impact monies received. Why? Because tax credits are not “expenditures”.

How much does the Guam Legislature budget for these LIHTCs? Zero.

Why? Two reasons. First, the tax credits are discounted and syndicated to investors in the US and applied to tax liabilities to the US Treasury, not to the Government of Guam. Second, Gov
Guam does not "spend" any money on the LIHTCs. In the highly unlikely case that any of the credits are ever applied to a GovGuam tax liability, the credits act just like any other tax credit and simply reduce the liability; it does not require GovGuam to pay anything.

GHURA has never certified funds for these LIHTC allocations, because there are no funds to be spent. The Department of Administration has never certified funds for these allocations, because there are no funds to be spent. The Government of Guam has never cut a check for these allocations, because there are no funds to be spent.

The leading case to analyze whether the allocation of LIHTCs constitutes an “expenditure of public funds” is the California Court of Appeals case, State Building and Construction Trades Council of California v. Duncan (2008) 76 Cal.Rptr.3d 507, 162 Cal.App.4th 289.

Under California and federal Prevailing Wage Law, the prevailing wage must be paid to workers if the project on which they are employed is ‘paid for in whole or in part out of public funds’." The developer in that case argued the project was a private project, thus payment of prevailing wage was not required.

The issue in that case was whether the award of tax credits under a LIHTC program constituted an “expenditure of public funds”. The trial court ruled it did; the Court of Appeals reversed and ruled it did not. The Court held,
“Tax credits are, at best, intangible inducements offered from government, but they are not actual or de facto expenditures by government.” [Emphasis added.]
The Court of Appeals looked, in part, to tax decisions to describe the nature of LIHTCs.
“There is, moreover, an impressive body of authority, much of which was cited by the Director in his coverage decision, that excludes tax credits from the category of goods and services that amount to public assets or are treated as the equivalent of money. For example, within the context of California's personal income tax system, a credit is treated as something that "involves no expenditure of public moneys received or held ... but merely reduces the taxpayer's liability" at a future point in time. (Center for Public Interest Law v. Fair Political Practices Com, supra, 210 Cal.App.3d 1476, 1486, 259 Ca.Rptr. 21.) Federal tax law is to the same effect: it likewise does not recognize receipt of a tax credit as a taxable event, on the theory that the taxpayer "has received no money or other `income' within the meaning of the Internal Revenue Code." (Randall v. Loftsgaarden (1986),478 U.S. 647, 106 S.Ct. 3143, 92 L.Ed.2d 525 (Randall).) [Footnote omitted; emphasis added.] The credits "have no value in themselves," only the contingent benefit "to reduce the taxes otherwise payable." (Id. at pp. 656-657, 106 S.Ct. 3143; see also id., at pp. 657-659, 106 S.Ct. 3143 [credits have "economic value" only indirectly to extent they reduce tax liability].)”
The Court rejected the claim that convertibility of credits to cash made them an “equivalent of money”.
“The fact that LIHTCs may indeed be marketable by others, after they have been allocated by the state, does not establish that they have a realizable monetary worth to the state before they are allocated. (See Griffin, supra, 324 F.3d 330, 355 ["the only property interest the State has in the tax credits is purely abstract or theoretical, even after ... [the project] is completed"].)”
The Court rejected the argument that the State acquired or exchanged anything of value as a result of the tax allocation.
“[T]the operative point is that the purchase price is not paid to the state. The value for which would-be buyers pay accrues when the LIHTCs come within the disposition of the developer for the project, not the state. It is from the developer, not the state, that "persons or entities with tax liabilities" purchase an ownership interest in the underlying project. The buyer realizes the value of the tax credit only when – and if – the project is completed in a timely fashion, becomes operational, and remains so for a number of years.”
The Court acknowledged, as being beside the point, “that tax credits are an important mechanism for achieving objectives the Legislature deems in the public interest.” It said,
“But their undoubted importance and utility is not at issue here. Tax credits operate to reduce future tax liability, and cannot be used until the low-income project is built and operating. (26 U.S.C. § 42, subd. (f)(1); Cal.Code Regs., tit. 4, § 10328, subd. (a).) Further, any worth the credits may have is obviously predicated on the taxpayer having tax liabilities to offset. In other words, the worth of LIHTCS is, at the time they are allocated by the CTCAC, speculative and contingent upon future conditions. [Footnote omitted.]

“The United States Supreme Court has held that the mere receipt of a tax credit confers no economic benefit because the credits "have no value in themselves." (Randall, supra, 478 U.S. 647, 656-657, 106 S.Ct. 3143, 92 L.Ed.2d 525.)”
It concluded,
“LIHTCs are not property. Allocated LIHTCs represent only the possibility of future benefit that may be realized after construction or rehabilitation of the proposed project. (See Randall, supra, 478 U.S. 647, 656-657, 106 S.Ct. 3143, 92 L.Ed.2d 525; Griffin, supra, 324 F.3d 330, 355.) We therefore hold that they do not amount to either the "payment of money or the equivalent of money" within the scope of subdivision (b)(1) or the transfer of "an asset of value for less than fair market value" within the scope of subdivision (b)(3).” [Code references are to California Prevailing wage law; footnote omitted.]
The LIHTC program is part of the US Internal Tax Code, and is described by the US Department of Housing and Urban as an "an indirect Federal subsidy" underwritten by tax credits.

HUD further explains, "Each year, the IRS allocates housing tax credits to designated state agencies - typically state housing finance agencies - which in turn award the credits to developers of qualified projects. ... The state allocating agency must develop a plan for allocating the credits [a "QAP"] consistent with the state's Consolidated Plan. Federal law requires that the allocation plan give priority to projects that (a) serve the lowest income families; and (b) are structured to remain affordable for the longest period of time." (http://www.hud.gov/offices/cpd/affordablehousing/training/web/lihtc/basics/ )

One thing that stands out in the implementation of the LIHTC program is the lack of uniformity of application and implementation among and within the states and territories, due entirely to the broad discretion allowed to the administering agencies to tailor housing programs to address particular circumstances and answer different policies and needs.

The Guam QAP underscores that discretion:
• "The executive director shall have the right to defer the consideration of any application if, in his sole discretion, such deferral is deemed in the best interests of meeting housing needs."

• "The amount of tax credits reserved or allocated to a particular project will be limited to the amount GHURA, in its sole discretion, deems necessary to make the project feasible."

• "GHURA reserves the right to disapprove any application or project for any tax credit reservation or allocation, regardless of ranking under the criteria and point system as contained in section III of this allocation plan."

• "GHURA reserves the right, in its sole discretion, to (i) hold back a portion of the annual state and federal housing credit ceiling for use during later reservation cycles, (ii) carryover a portion of the current year's housing credit ceiling for allocation to a project which has not yet been placed in service, and (iii) under certain conditions, issue a reservation for the next year's housing credit ceiling."
I have to admit that these broad discretions do not sit comfortably with my sense of order under the procurement law. But the LIHTC program is not a procurement program, and we cannot judge it as such. It is simply a tax incentive, offered under limited conditions, to achieve a socially desired policy objective, like so many other tax credits, deductions and allowances.

The procurement law is not some over-arching paradigm against which other government activity must be governed. As broad as is its relevance in day-to-day government operation, it is nevertheless proscribed by application solely to contracts made by the government, involving the expenditure of public funds, to acquire for itself supplies, services and construction. It is to tax law, and here specifically US tax law, that parties must look to their rights and remedies as regards LIHTCs, not the procurement process.

Sunday, December 25, 2011

Putting "potent" back in "potential"

Government contractors beware: 2012 may be the year of the government audit.
Government contractors have always faced an abundance of potential audits.

Financial scrutiny of contractors is expected to rise as the government expands its auditing workforce and the contracting pie shrinks. Agencies are coming under greater congressional scrutiny, and public pressure is mounting to ensure the taxpayer is getting the best deal.

One indicator came in a Nov.15 directive from Office of Management and Budget Director Jacob J. Lew, who ordered federal agencies to put more resources and emphasis into their suspension and disbarment programs.

Lew referenced a recent Government Accountability Office study which, he said, found that “more than half of the 10 agencies it [GAO] reviewed lacked the characteristics common among active and effective suspension and debarment programs: dedicated staff resources, well-developed internal guidance and processes for referring cases to officials for action.”

While no two audits are the same, government auditors are likely to place a greater emphasis on internal controls during 2012.

They will review your stated policies and procedures to determine the strength of your control environment, then typically make a random selection of transactions (for example, vendor invoices, employee time cards, travel vouchers) and scrutinize supporting documentation.

The auditors are looking to determine if the contractor’s policies and procedures were followed, approvals documented and internal controls enforced.

In addition, there are now many prospective government contracts that will be awarded only after rigorous assessments of the adequacy of the contractor’s business systems and internal controls. Contractors now will simply pass or fail, rather than possibly passing with certain deficiencies. All deficiencies must be addressed successfully before the contractor’s system is deemed adequate, and the contract awarded.
As always, read the linked articles for more.

PIGGYBACKING: Rather than a new post, below is another article, from Bloomberg, in the same vein, albeit noticed a couple of days later.

Fraud Fight Has U.S. Seeking to Ban Record Number of Suppliers
Federal agencies have proposed blocking 1,006 companies and individuals from contracting so far this year, as well as asking a judge to ban a unit of food-processing giant Cargill Inc. of Minneapolis, in a process known as debarment.

U.S. agencies are under pressure after a series of congressional hearings and reports from inspectors general and the Government Accountability Office faulted procurement officials for failing to keep unqualified or ineligible vendors out of the $500 billion-a-year federal market.

Contractors can be proposed for debarment for poor performance as well as a variety of ethical issues, including overbilling or falsely claiming a company is owned by a disabled veteran in order to win special awards. In some cases, debarment is automatic, such as when a contractor is convicted of violating the Clean Air Act or Clean Water Act. Debarment typically lasts three years.

The number of contractors suspended from winning work has also surged, to 1,044 so far this year, up 40 percent from last year’s 747 and the most of any year since at least 2000, according to the GSA data. Suspensions are typically for short periods and can be initiated with less evidence than proposed debarments because they are designed to protect the government while investigations are occurring.

The Small Business Administration has expanded its efforts to ban contractors by looking across agencies for companies that misrepresent their size or ownership status to win work reserved for small vendors or companies owned by disadvantaged groups, said John Klein, the agency’s acting director for government contracting and associate general counsel for procurement law. “The mission is to make sure that legitimate small businesses benefit from our program,” Klein said.

Some contractor advocates say the government may be too aggressive in pursuing debarment in some cases, since even proposing a company for debarment means it won’t be able to win new contracts until the situation is resolved.

After a company has been proposed for debarment, it can take a year or more before a final decision is made, said Robert Burton, a former acting administrator of the Office of Federal Procurement Policy during the Bush administration who is now a partner at Venable LLP in Washington.

Moira Mack, a White House Office of Management and Budget spokeswoman, said the agency provides due process to all contractors facing suspension or debarment.

“For too long, the government failed to use suspension and debarment, even in the face of egregious conduct by contractors,” Mack said in an e-mailed statement. “That’s why this administration has been pushing for tougher oversight of contractors, and we’ve seen results.”

Read more: Fraud Fight Has U.S. Seeking to Ban Record Number of Suppliers
Important: Can you afford to Retire? Shocking Poll Results





Friday, December 23, 2011

Keep your specs on

If your vacation was ever taken in the manner that many solicitations are processed, you'd never get there, or get where you intended, or get back again.

When planning a vacation, you very carefully (unless on a free-abandon adventure) decide where you want to go, when and where to stay, what to do, etc.; and if you can book the time and place. You also want to shop around for best prices, appropriate accommodations, class of travel, etc.

Then, absent misadventure, you stick to the plan and have the photos to prove it. Even if, along the way, you realize you could have done things a bit differently and saved yourself a little money or convenience.

Once everything is planned and booked, changing plans becomes expensive and often impossible. You have, after all, caused airlines, hotels, tour companies, etc., to modify their plans to accommodate yours. Upsetting you plans causes them inconvenience and often costs and damages.

Procurement should be approached with the same understanding.

First, determine what it is you need. Then find out if it is available in the market. Write the specifications you need to get that. Then get quotes, and go and have fun.

What we too often find with procurement, though, is that people want to change their plans after the bookings have been made and deposits paid. The following article from Suffolk, Virginia, USA, illustrates this common occurrence.

Contract lawsuit dismissed
A lawsuit against the city of Suffolk was dismissed this week after the city canceled a contract it had signed to purchase a mobile command bus for the police department.

The lawsuit involved a mobile command vehicle the Suffolk Police Department planned to purchase with a Port Security Grant of more than $600,000.

The bus, according to a presentation to City Council by Police Chief Thomas Bennett earlier this year, would help the department improve its response to natural disasters, hostage situations and other incidents.

Matthews Specialty Vehicles Inc., submitted a bid of $655,292 for the vehicle. Farber Specialty Vehicles submitted a lower bid of $589,000 and was given the contract.

Matthews promptly cried foul, saying that Farber’s bid did not follow the specifications listed in the bid invitation, including for such things as the width and weight of the bus, dimensions of the radiator, construction and flooring materials, the style of cabinets and ceilings and more.

After the lawsuit was filed, Suffolk Circuit Court granted an injunction that prevented the city from proceeding with the purchase until the trial was concluded. Matthews alleged that Suffolk had violated the Virginia Public Procurement Act.

Thursday, December 22, 2011

Trading on inside information unfair to competition

The Office of Inspector General of the US Dept. of Veterans Affairs has determined that it was unfair to award a contract to an incumbent based on an evaluation that gave the incumbent points for its knowledge of the existing system and reduced points for bidders who lacked that knowledge. File this under leveling the playing field.

Final Report: Review of Secure VA-Chief Information Security Officer Support Services Acquisition Process
The technical evaluation process favored awarding the contract to the incumbent, Booz-Allen Hamilton, based on its performance as VA’s Information Assurance and Information Technology Security Services contractor for the past two years.

Documentation shows that the panel considered knowledge or unfamiliarity of VA procedures and practices as “strengths” or “weaknesses” in assessing the “understanding of the problem” requirement in the RFQ. As a result, the panel assigned nine “significant strengths” to the Booz-Allen Hamilton proposal; six of those “strengths” made specific references to knowledge of VA procedures and practices.

However, the lack of knowledge of VA procedures and practices was identified as a weakness in the evaluation of other offerors. The strengths and weaknesses associated with knowledge of VA procedures and practices were key factors in the decision to award the contract to Booz-Allen Hamilton.

VA traded off lower cost in favor of vendors’ technical knowledge of VA procedures and practices in evaluating the offers. If knowledge of VA procedures and practices had not been used as a key evaluation factor, another vendor might have won the contract at lower cost to the Government.

Booz-Allen Hamilton’s proposal was the highest cost option; however, the weighting of its knowledge and experience with VA procedures and practices was a key factor in Booz-Allen Hamilton winning the technical evaluation and ultimately the contract award decision.

We disagree with Management’s contention that Booz-Allen Hamilton’s nine significant strengths justified selecting it for contract award despite the fact that it was the highest bidder. As noted in the Source Selection Decision Document, Booz-Allen Hamilton’s cost of approximately $133 million reflected a premium of 16 percent ($18 million) and 22 percent ($24 million) over the two other offerors.

VA justified this premium because of the perceived significant strength and low technical risk from Booz-Allen Hamilton’s extensive knowledge, understanding, experience, and expertise in support of VA’s enterprise-wide information security and risk management program.

Further, although it would have been helpful to substantiate the selection decision, Management did not provide a labor-rate cost analysis justifying the premium price paid for the contract award. Such an analysis would have compared the labor rates of all proposals and determined whether Booz-Allen Hamilton’s labor rates were reasonable.

While the award decision may have resulted in a low risk to the Government and a decreased learning curve as Management asserted, VA should not have paid a premium price for the incumbent’s knowledge.

In our opinion, favoring the incumbent during the selection process did not promote full and open competition in accordance with the Federal Acquisition Regulation.

This practice puts VA at risk of awarding future “de-facto” sole source contracts at greater expense to the Government because of reduced competition.

Management based its assertion on a GAO ruling that “It is common for an incumbent to possess and receive evaluation credit for unique advantages which the government is not required to neutralize, and this advantage does not constitute an unfair competitive advantage or represent preferential treatment by the agency.”

We agree that organizational knowledge can be a key consideration in evaluating offers and a deciding factor when multiple bids are indistinguishable.
[Subtext: Here, bids were distinguishable by significant price differentials, without justification the price paid was reasonable.]
However, this ruling as well as another GAO decision cited by Management further emphasized the importance of disclosing in the RFQ how relative experience will be evaluated during the selection process and when giving credit to the incumbent. As such, VA should have identified such knowledge as a significant evaluation factor in the RFQ before using it as criteria for rating purposes. We maintain that the Department’s failure to disclose knowledge of VA practices as a significant evaluation factor prevented all vendors from submitting comparable proposals to emphasize their specific VA experience, placing potential contractors at a disadvantage in the bidding process.

Therefore, we will evaluate VA’s contract award decisions in future audits to determine if evaluation panels assess vendor proposals based solely on evaluation factors stated in the solicitations.

Friday, December 9, 2011

Red tape or red herring?

It is a perennial ruse of political detractors and government agencies to blame the procurement process for the failure of politicians to appropriate and government to properly spend. Here's a current example.

MPs brand MoD’s procurement ‘extraordinary failure’
In a report published today, the PAC[Public Accounts Committee] found that, since the 1998 Strategic Defence Review, there had been an ‘extraordinary failure’ to produce necessary principal armoured vehicles. These include tanks and other reconnaissance and personnel-carrying vehicles.

The PAC blamed budget cuts, an overly complex procurement process and an ‘unrealistic culture’ where the MoD was demanding cutting edge technology it could not afford.

As a result, the armed forces will not have enough vehicles until at least 2025, making it more difficult to undertake essential tasks such as battlefield reconnaissance.

The reasons for this were ‘all too clear’, committee chair Margaret Hodge said, because £10.8bn had been taken from the armoured vehicles plans in the last six years as the department sought to balance its budget.

She added: ‘The MoD seems as far away as ever from establishing a clear set of affordable defence priorities. The problem for the armoured vehicle programme is that the department has yet to say how it is going to find the money to buy the vehicles it needs in future to carry out the full range of military tasks.’

Around £5.5bn will be spent on new armoured vehicles in the next ten years, but the report also warns this may be insufficient. It calls on the MoD to set out clearer procurement priorities, and to stop ‘raiding’ the armoured vehicles funding every time it needs to make savings.

As a result of the failure to produce vehicles through its core procurement programme, the department needed to be given £2.8bn by the Treasury to buy vehicles for the separate Urgent Operational Requirements programme.

The faster UOR process has been used to deliver mine-resistant vehicles for operations in Iraq and Afghanistan, but these are more expensive, the MPs said.

Responding to the report, defence minister Peter Luff said that ‘the armoured vehicle programme was left in a mess by the previous government’.

He added: ‘We are now sorting out their unrealistic and unaffordable plans by balancing the budget, investing real money in equipment and reforming outdated procurement practices.’
However, the minister said that the PAC was ‘misrepresenting the facts’ of some procurement deals.

‘It is not true to say the £1.1bnspent on armoured vehicles has not delivered any equipment. It has delivered Titan, Trojan and Viking vehicles, with Trojan and Viking used on operations in Afghanistan.’

He also said that the UOR process has been used correctly to ‘swiftly deliver world-class equipment to the frontline’.

While there may indeed be some problem with the procurement process, it was not detailed in this article. What was detailed is a failure of government to live within its means and aims. It then must resort to less competitive emergency procedures to compensate for its failure to properly plan and manage its acquisition needs, and, as this again reflects, emergency acquisitions tend to be more costly, if more expeditious, than competitive ones.

(For those unfamiliar with the term, "red hearing" refers to a
deliberate attempt to divert attention. See, Wikipedia here and here.)

Procurement controversies -- Hungary

Some of the story reported below is lost in translation to English, but the gist is clear.

Public procurement council contracts for spiffy new office – without public procurement tender!
In an almost comic display of the weak state of public procurement safeguards in Hungary, the country’s Public Procurement Council (KT) awarded a contract worth hundreds of millions of forints for the fit-out of its new offices without ever announcing an open bid tender for the job.

Transparency International said it asked the Competition Office and the State Audit Office to instruct the Public Procurement Arbitration Committee (KDB) to launch an investigation of the deal. But the KT said the technical specifications of the project excluded all other procurement options and that the KDB had approved its choice.

Monday, December 5, 2011

The difference between government acquisition and procurement

(Note:  Given I get a lot of hits to this article, let me clarify that procurement and acquisition are each defined in terms of the other.  The ABA Model Procurement Code defines the term "procurement" in terms of the "acquisition" of something (see, e.g., Guam's Model Code enactment at 5 GCA § 5030(o)). The FAR defines the term "acquisition" (see Subpart 2.101 (b), "Acquisition") and then discusses acquisition in terms of a procurement; it's definition of "procurement" in that same subpart says simply,  “Procurement” (see “acquisition)"

Without being pedantic about it, I use the terms with a nuanced difference detected in the common parlance:  acquisition is purchasing something without the trappings beyond mere contract law, but procurement is a formalized process, typically infused with a regime of accountability, transparency, due process, financial controls, and other trappings associated with bureaucratic, if not necessarily governmental, purchasing.  My use of the two terms here is more of the common connotations, not the technical.)

Government can acquire its needed construction services or it can procure them. This is an example of how a government simply acquires them:

Auditors Find Rampant Problems In Highway Construction Inspections
This report is a follow-up to a July audit that detailed potentially criminal, ethical and contracting violations in the [Maryland] State Highway Administration's Office of Construction.

auditors uncovered a contracting system that had few rules of its own and skirted existing law.

Contractors often used creative accounting to transfer unspent funds between different projects. Meanwhile, the construction inspection office did not maintain any documentation of what contractors were supposed to do, and had no standard method of estimating how much different projects should cost.

Contracts were often extended and modified without the required step of getting Board of Public Works approval, and new contracts were often awarded when there were still contractors doing work.

Maryland is broken up into several regions by the State Highway Administration, and construction services inspection contracts are given to people and agencies who will do inspections in a region for a fixed amount of time. State procurement law states that money can only be spent on the contract for which it was approved.

Auditors found that contractor were often involved in performing inspections in several areas, and tended to move the money they received between areas to cover for funds that ran out. For 10 contracts auditors looked at, nearly a fourth of all funds - about $11 million - were spent on different projects.

Contracting staff told auditors that this kind of borrowing funds was an accepted practice in their office. Myers said that this procedure is not accepted anywhere else, and he cannot recall finding another department doing this in other audits.

Auditors also found that administration staff also unilaterally extended contract times, never bringing any of the contracts to the Board of Public Works. The reason that contracts would be extended, the report states, is so unspent money in the contracts could get spent. About $26 million spent through unauthorized contract extensions should have been returned to the state for other needs, auditors wrote.

Construction inspection services contracts were often missing several critical pieces of information that could be used to ensure the state was getting its money's worth. Auditors found that contracts had no scopes of work - detailed lists of tasks that must be done under the contract.

Office of Construction personnel told auditors that the contracts were detailed enough, and putting together a scope of work for each one would be cumbersome. Auditors disagreed on both counts.

Auditors also found that there was no single way to determine the maximum amount that a contract could be worth. Auditors examined four contracts worth $34 million, and asked the office for documentation backing up the money spent on each. No sensible documentation was provided, and different employees gave completely different methods of trying to estimate the costs.

The office sometimes gave inspection contracts for an area to multiple contractors. Auditors found that far too many contracts were given for no reason. One area had $15.4 million unspent on inspection contracts, and received Board of Public Works approval for another $16 million. Another area had $36.5 million in unspent contracts floating around, and received Board of Public Works approval for another $10 million.

Auditors received no justification for these initial contracts, and reported that the office never reported the amounts of other pending contracts to the Board of Public Works.

This is quite remarkable -- and ironic -- since Maryland was an early adopter of the ABA Model Procurement Code and seemingly had implemented it statewide. It just goes to underline the importance of properly implementing the system that is actually adopted.

Thursday, November 24, 2011

UK's National Health Service Pilot Program Procurement Pulled

The National Health Service in the UK decided to test a plan to provide a new program for health services delivery. It is not clear to me just what the program entails, but it appears to be some kind of doctor appointments/referral system. The system was to be installed in a variety of regional centres. You can read the story and decipher for yourself at Procurement breach throws 111 pilots into disarray.

Since this was a two year test run, someone (or ones) some where (or wheres) made the decision to simply award the test sites services ("pilots") without a competitive process. At the last minute, the roll-out was cancelled and awarded pilots were cancelled. As the article explains,
Contracts for pilots covering NHS Westminster, NHS Kensington and Chelsea, NHS Hammersmith and Fulham and NHS Hillingdon were pulled after NHS North West London admitted its decision to award contracts without any tender process could be open to legal challenge.

The move has raised fears that pilots elsewhere in the country, some of which have also been awarded rather than put out to tender, could also be open to challenge – a prospect which could throw the national deployment of 111 into disarray.

Pulse understands the move has triggered anger from local GPs who had invested time and resources in planning how to integrate with the 111 pilot.

The wider impact of the decision remains unclear, amid confusion over whether NHS trusts are required to put pilots out to tender. Contracts for the full rollout of NHS 111, some of which are expected to be worth as much as £100m, will need to undergo a full competitive tender process, but the Department of Health told Pulse there was no central guidance on whether pilots should be put out to tender, and it was considered a matter for ‘local commissioners, subject to their legal advice'.

Dr Richard Vautrey, GPC deputy chair, said: ‘GPs are right to be angry about this, but it also reflects the complexities of the 111 procurement agenda and the pressures PCT clusters and CCGs are under because of the very tight timescale set by DH.'

Dr Agnelo Fernandes, the RCGP's urgent care lead and chair of Croydon Healthcare Consortium in Croydon said: ‘They are pilots so they are not covered by the same rules as full procurement but CCGs need to cover themselves by doing some kind of limited procurement, even if it is a pilot for 111.'
This is an instructive article for two purposes (at least). First, it illustrates, again, the way procurements too often get trampled in the rushed implementation of some political bright idea. Time and again this leads to unhappy endings. We should learn from these examples to get it right the first time. It's all part of the planning principle.

Second, it raises the matter of remedies for broken procurement. Here the procurement was cancelled, as were awards already made. Not all regimes allow awards to be rescinded, which I consider a moral hazard because it means if you hurry fast enough you can get away with abusing the process. Guam law also allows contracts that have been awarded by a faulty procurement process to be cancelled, as does the US federal law.

Insofar as this article raised the notion that "pilot programs" should somehow be exempt from general procurement requirements, I consider that to be a bad idea. Guam law, for instance, requires any contract by the government to be governed by the procurement process. There is a very big advantage that accrues to an incumbent contractor, and if a contractor could gain that advantage without competition, it would give the contractor an even more unfair advantage.

Thursday, November 17, 2011

"Buying local" loco buying?

Loco: "Spanish for "crazy", "insane", "mad".

Buy American, buy South African, buy local. There are calls around the world for government to spend its local tax dollars on local resources. It has a gut-level appeal.


If carried to an extreme, however, it can backfire, as excerpts from the following opinion piece from South Africa explain.

Why local procurement rules are a dead end by Jasson Urbach, an economist with the Free Market Foundation.
According to a Business Day news article by Setumo Stone (Buy-SA bid to channel billions to local companies, 1 Nov. 2011), "Business, the government and labour signed an accord on local procurement on Monday, pledging to increase their purchasing of goods and services from South African producers to an "aspirational target" of 75% in a bid to boost industrialisation and to create employment".

Proponents of the "local is lekker", "Buy South Africa" and the more recent "Proudly South African" initiatives argue, essentially, that buying local keeps the money in the economy and boosts growth and employment. It's easy to recognise the simple logic of the protectionist movement argument: if we encourage people to buy locally (mostly by pulling on patriotic sentiment) then we increase demand for domestically manufactured goods and with more goods being produced locally more South Africans will get jobs.

But is compelling people to buy local a good idea? And, surely, if 75% is good for the local economy then wouldn't inducing people to buy 100% locally be an even better option?

Let's assume that I am a successful car manufacturer. By successful I mean I run a profitable business without relying on special privileges from government at my fellow taxpayers' expense. To manufacture my make of car, I import the engine from Germany at a cost of R100,000 per unit.

Now, suppose I have a neighbour who, using South African labour, can manufacture an engine of equal quality but with a price tag of R1 million. Should I support the ‘local is lekker' drive and buy the engine from my neighbour?

if, instead of making an engine of equal quality but significantly more expensive than the German engine, my neighbour makes a really shoddy engine that doesn't work quite as well. The smart business thing for me to do would be to continue buying the engine from Germany if I want to produce my car at the best price and make enough profit to keep my workers suitably rewarded. The savings I make by importing the engine will allow me and my workers to buy a lot of other goods and services, some produced locally and some imported.

The tried and tested way to prosperity is to produce goods and services that other people actually want and at a price they can afford or are prepared to pay. I cannot be expected to buy the engine from my neighbour just because he lives in the same country as me, irrespective of the price or quality of the good he produces.

I could well decide to buy the engine from my neighbour out of compassion or because I like the guy, but this would amount to charity. If business, government and labour force me to buy from my neighbour and I receive less value for my hard earned cash, the net result is that I am simply transferring some of my wealth into my neighbour's bank account.

Individuals who choose voluntarily to help their countrymen by buying products at a higher price or of a lower quality, do so as an act of compassion and must do so at their own cost. There is no decent reason to force or compel people and businesses to do what the simple logic of proponents of the "Buy local" initiative deem is right at a cost to the country in general and the poor in particular.

Should we ‘buy South African' regardless, to preserve money and jobs domestically? No, obviously, if it means we would be buying non-operational, overpriced goods from each other.

By restricting everyone to buying from and selling their goods and services to fellow countrymen only, we limit the range of products available as well as the people we can buy from and sell to, and ultimately everyone is worse off.

I sense a bit of hyperbole in the argument, but I have to say it comes in no small part to a failure of the author to clearly state the facts here.

The claim is implied that this is a compulsory mandate, but the words used are more precatory: "pledging", "local procurement accord", "we encourage people to buy locally (mostly by pulling on patriotic sentiment)", etc.

Surely there is some level of multiplier effect locally if local money, raised through locally assessed taxes, is recycled through the local economy rather than exported. It would not be enough effect to require that all, or even a large part of purchases be made from local sources, but it does have not an insignificant effect, and it does sit better with the local populace if the community first looks to its own, giving itself the benefit of any doubt as to value for money.

Most buy government contracting local laws I have seen (but I have not done any kind of empirical research) give an edge, but only a marginal one, to local vendors. Guam's procurement law is actually one of the more extreme I've seen, giving a local business a 15% price differential advantage to a non-local vendor or service provider, assuming responsive bids or proposal. However, it has defined "local" in a way that makes it very easy to qualify as local, which dramatically reduces the discriminatory impact. For instance, there are NYSE-listed international corporations doing business "locally" on tiny Guam.

The Guam Chamber of Commerce is currently supporting a "buy local" campaign, aimed not at government contracting but the wider community. This program only hopes to encourage locals to buy 10% of their needs from local sources, including local wholesalers, most of whom acquire the bulk of their goods (if not all), from off-island. It, like the South African program is described, is an "aspirational" campaign; it has no enforcement mechanism. It makes no claim that people should buy locally if the product does not pass muster, and in doing so, by encouraging pride in local production, lifts the benchmark for quality, challenging local producers to better off-island sources. It's meant to change the habits of the modern electronic marketplace, not the tastes.

Is that such a bad thing?

Wednesday, November 16, 2011

Of bad actors and Emmys

Should a bad actor be given an Emmy award?

How about a contract award?

Read on.

Lawmakers, OMB push to ban more `bad-actor' contractors by Charles S. Clark
At a Wednesday hearing of the Senate Homeland Security and Governmental Affairs Committee, Chairman Joe Lieberman, I-Conn., expressed alarm that a series of reports from the Government Accountability Office and inspectors general have shown a reluctance of many agencies to refer unsatisfactory contractors to the Excluded Parties List System maintained by the General Services Administration.

A Pentagon report "just last month shows that over a 10-year period, DoD awarded $255 million to contractors who were convicted of criminal fraud; and almost $574 billion to contractors involved in civil fraud cases that resulted in a settlement or judgment against the contractor," Lieberman said. "Last year, the Department of Homeland Security's inspector general found 23 cases where the department had canceled a contract because of poor performance, but in none of those cases did DHS suspend or debar the contractor."

The Federal Emergency Management Agency, despite the existence of an anti-fraud task force following Hurricane Katrina in 2005, has not sent a single name to the list, Lieberman added, noting that the rarity of suspensions and debarments has been a concern of the committee as far back as 1981.

Sen. Claire McCaskill, D-Mo., regretted that proposals to require more suspensions and debarments founder because of a fear of litigation, because it's "too much trouble," some contractors are seen as "too big to fail," or "it is unclear who is accountable for a failure" to pursue that course, she said.

Dan Gordon, the departing administrator of the Office of Federal Procurement Policy, said the system's "weak link" is ensuring that a fraudulent contractor is flagged for action in a timely way. "Sometimes the referral takes too long, as historically agencies have been very bad about sharing, either because officials didn't check the list, checked it too late, or because of problems in the spelling of an entity's name."

But he expressed skepticism toward any prospective legislation making certain referrals mandatory, saying agency cultures differ and mandatory referrals that take away discretion could undermine the role of suspension and debarment officials.

Panelists agreed that the model policy is that practiced by the Air Force. Steven Shaw, deputy general counsel for contractor responsibility at the Air Force described two recent suspensions, one involving the Boeing Co.'s launch systems units and the other involving programs within L-3 Communications. Sixty-two percent of his suspensions and debarments are "fact-based," he said, meaning his team doesn't wait for the Justice Department to bring criminal charges. "We take a broad view of the type of misconduct, not just criminal fraud but as it relates to business integrity, tax issues, the Foreign Corrupt Practices Act or commercial fraud," he said.

The Air Force also uses a "carrot-and-stick approach that is aggressive at the front end" but still allows contractors to prevent fraud through risk management and ethics programs.

Ranking committee member Sen. Susan Collins, R-Maine, who as a staff director worked on the 1981 hearing chaired by then-Sen. William Cohen, R-Maine, reminded the hearing that the goal of suspension and debarment is "not to punish contractors but to protect" the taxpayer, and that allowing "bad actors" to win new contracts is "not fair or ethical to the honest contractors."

Private contract law imitating public contracting?

The case is often made, in Guam and the US anyway, that government contracting should be more like private contracting. In Canada, at least according to the following account by Paul Emanuelli, who has already featured beneficially in this blawg, it seems government contracting is providing principles either "found" in common law contracts or implied there.

In the US, it is well settled that, in government contracting, any change made to the contract terms beyond the "scope of the contract" should necessitate a new solicitation. On the other hand, I am not aware of any private law of contract case coming to any similar conclusion; the freedom of parties to contract is usually paramount. Any potential contractor bidding on a private contract does so with little safeguards: let the bidder beware.

Not so in Canada, so it seems (and this may be a good thing, no?).

Courts prohibit changes to contracts after bids are submitted by Paul Emanuelli
In its decision in Protec Installations v. Aberdeen Construction Ltd., the British Columbia Supreme Court found that the owner was not allowed to make changes to the tender call rules or negotiate material changes to the contract after the close of bidding.

The case involved a tender call for the construction of a mall in Richmond, British Columbia. With full knowledge of the low bidders’ price, the second-lowest bidder entered into post-bidding negotiations with the owner and submitted a revised bid for $5,000 less than the low bid. That bidder was awarded the contract. The low bidder sued.

The court found that the owner was not allowed to cut the low bidder out of the process while permitting a competitor to re-negotiate the terms of the deal and re-tender its price. The court found that the low bidder was prejudiced by the post-close indulgences granted to the competing bidder and awarded the low bidder damages.

Similarly, in its decision in Health Care Developers Inc. v. Newfoundland, the Newfoundland Court of Appeal recognized that an owner’s good faith duties include the duty to avoid varying the terms of the awarded contract from the terms contained in the tender call.

The case involved a tender call for the construction of health facilities and other buildings. The Court of Appeal noted that “In respect of the decision to award a contract other than that contemplated by the tender call, the trial judge found this was also a violation of the common law principles of contract.”

The Court of Appeal agreed, finding that the need to award a contract that is consistent with the contract contained in the tender call is one of the primary implied duties that applies under the duty of fairness and good faith

As this case confirms, any post-bidding changes to the awarded contract can undermine the integrity of the formal bidding process and the equal footing upon which all bidders are entitled to compete.

Furthermore, in its June 1996 decision in Emery Construction Ltd. v. St. John’s Roman Catholic School Board, the Newfoundland Court of Appeal also found that a privilege clause does not allow an owner to award a contract that varies from the Contract B contained in the tender call.

The case involved a tender call for the construction of a new school. The low bidder was bypassed in favour of the second-lowest bidder. The low bidder sued.

The Court of Appeal stated that the school board was not permitted to use its privilege clause to apply undisclosed award criteria or vary the terms contemplated in the tender call: such clauses do not permit the owner to choose among bidders on the basis of criteria not disclosed to the bidders nor does it permit the owner to award something other than contract B.
Whilst these cases seem to be about private contracts (the first involving a shopping mall and the third involving a private Catholic school), the rationale for the holding seems, on the other hand, to be derived, as quoted from the Newfoundland case, from and for government contracting:
The doctrine of good faith is applicable in this case, the necessity for its application to government tendering to “protect the integrity of the bidding system” was expressed in Kencor and I need not state the principle more broadly than that it is a part of the law of tendering for Government contracts.
I would be interested to know for certain that the scope of contract principle is being applied to private contract bids. Given its basis in "good faith", a concept that has yet to find firm roots in US contract law generally (especially beyond the Uniform Commercial Code), I'd be skeptical about relying on it in the US.

But I would encourage pushing the envelope. If private owners truly ask private bidders to go to cost and bother of bidding on projects, at the very least, there should be some kind of promissory estoppel to prevent the kinds of injustices the Canadian cases seem to mitigate.

Tuesday, November 15, 2011

As one door closes, another opens ...

Government contracting is a double bladed sword. Matters of public governance inevitably make it a cumbersome process that frustrates the nimble creative, and creatively destructive, instincts of so-called free markets.

The following two articles popped up on my radar screen and offer competing views of the advantages and disadvantages of trading with Caesar. As usual, you are best served by reading the full article.

Why Selling To The Government Can Downgrade Your Startup
First Greece, now Spain and Italy. Across Europe, historically solvent sovereign governments are suffering from an acute case of systemic deficits. Now, more than ever, government agencies in the US and abroad are lousy startup customers.

Although government customers are not without their merits, startups should only target such bureaucracies when they can obtain a market price and avoid an extended and costly sales process. By focusing on commercial enterprises that share your adVenture’s sense of urgency and profit motive, your startup can maintain its solvency and avoid a credit rating downgrade.

an entrepreneur’s two most valuable assets are time and money. Government customers abundantly waste both of these assets by negatively impacting a startup’s cash flows while causing it to spend unnecessary time participating in laborious approval processes and elongated sales cycles.

Vendor Approval Process: In the case of the US Federal Government, the steps a company must traverse to become approved by the Government Services Administration can take years and cost a small fortune of precious startup capital – time and money most startups simply cannot afford.

Slooooooow Mover: The typical government procurement process is not driven by a sense of urgency.

Slooooooow Payer: The government is a notoriously slow payer. Officially, the Prompt Payment Act requires the US government to pay its vendors in 30-days “after receipt and acceptance of material and/or services.” In actuality, payments routinely extend beyond this threshold, with 120-days outstanding not uncommon.

Capricious: Non-government customers sometimes make irrational decisions that are difficult to predict; government customers do so on a routine basis. As the decision makers come and go with the latest election cycle, a startup can lose a government account for no reason other than the newly elected officials want to give a hearty "thank you" to a company that greased the skids for them during the election. In addition, government budgets are prone to draconian, across-the-board cuts which often have no correlation to the efficacy of specific programs or vendors’ solutions. It is frustrating to lose an account to a formidable competitor. It is downright criminal to lose a hard-fought sale because of crony capitalism.

Set Asides: Despite the controls bureaucrats create to ensure a fair procurement process, it is any but. Most startups do not have the financial wherewithal to make adequate campaign contributions to purchase government set-asides or win no-bid contracts. In most cases, startups are “set aside” to make room for Big Dumb Companies (aka Big Dumb Campaign Donors), when it comes to obtaining lucrative government contracts.

Bro Factor: An inherent advantage startups enjoy is the Bro Factor. Unfortunately, this startup weapon is difficult to deploy when dealing with governments, due to the dispassionate nature of most bureaucrats. [Does this contradict the prior two factors?]

Mitigating Downside: Unlike the private sector, in which many buyers are focused on gaining a competitive advantage, the fear of loss is often the primary criteria motivating politicians and their appointees

High Volume / Low Margin: The combination of the low profitability of competitive bid contracts, the large size of many government procurements, and extended payment terms can be deadly for a fledging startup.

The Tierney Of Low Expectations: Post sale, governments are typically undemanding customers, due to the lack of accountability in most bureaucratic organizations. Aggressive commercial customers help startups improve its value proposition with frank criticism, product roadmap suggestions and new use cases.

Barrier To Entry: Once you are in with a government entity, the same inertia which made it difficult for you to secure the sale will make it similarly challenging for your competitors to displace you.

Low Default Risk: Unless you are selling to Greece, Mozambique or California, the risk that you will never get paid is relatively low.

Budget Drain: Government workers are trained to drain their budgets annually to avoid being granted a smaller budget in the following year. Approved vendors who enjoy an existing relationship with the government can leverage this inclination to waste money at the end of each fiscal year by pre-selling additional products and services.

Read more: http://infochachkie.com/government/#ixzz1dnGA8e2U

Procurement Service opens global resource market
The state procurement agency [of South Korea] has unveiled its strategy to widen exports of its procurement system to about 20 countries, paving the way for local suppliers to find deals abroad.

Public procurement market has been difficult to penetrate for local companies as many authorities have placed restrictions on foreign ownership and subsidies reserved for local suppliers. But regulations favoring domestic firms are being lifted with more trade pacts, creating level-playing field for companies to bid for deals from overseas.

The Public Procurement Service, tasked to manage state-owned land and properties, has put its priority in selling Narajangteo, an electronic procurement system developed by Samsung SDS.

Narajangteo, also known as MER-Link, manages government’s contracts with private suppliers by processing electronic bidding, certification, payment settlements, document distribution and workforce planning. Roughly translated as “national marketplace,” the homemade e-system helps to integrate and standardize procurement process. It has been sold to Costa Rica and Vietnam and Mongolia are scheduled to adopt the system within a year or so. Choi is confident he can expand this to Europe and Africa.

“Export of Narajangteo lays the groundwork for local suppliers to find deals from foreign governments. Selling the system widens Seoul’s network with foreign officials, which helps us share information with local companies,” Choi said. “(Importing countries) having the same system as we do is a great advantage to Korean suppliers trying to channel resources there,” he added.
Of course, Samsung is hardly a start-up company.

Sunday, November 13, 2011

The cost of sole source pricing

Disclaimer: The article below is meant to be a jumping off point for the discussion of procurement principles that follows. The discussion does not claim to evaluate the law or facts of the matters reported in the article. As usual, the article is used and presented as if it were a hypothetical, for analytical purposes only.


Cost, need questioned in $433-million smallpox drug deal
By David Willman, Los Angeles Times
Once feared for its grotesque pustules and 30% death rate, smallpox was eradicated worldwide as of 1978 and is known to exist only in the locked freezers of a Russian scientific institute and the U.S. government. There is no credible evidence that any other country or a terrorist group possesses smallpox.

If there were an attack, the government could draw on $1 billion worth of smallpox vaccine it already owns to inoculate the entire U.S. population and quickly treat people exposed to the virus. The vaccine, which costs the government $3 per dose, can reliably prevent death when given [only] within four days of exposure.

Dr. Nicole Lurie, a presidential appointee who heads biodefense planning at Health and Human Services, cited a 2004 finding by the Bush administration that there was a "material threat" smallpox could be used as a biological weapon. "I don't put probabilities around anything in terms of imminent or not," said Lurie, a physician whose experience in public health includes government service and work with the Rand Corp. "Because what I can tell you is, in the two-plus years I've been in this job, it's the unexpected that always happens."

Worrying about worst-case scenarios is what biodefense planners do. In the case of smallpox, millions of Americans have no immunity because the vaccination of civilians ended in 1972. And there is no way to guarantee that a rogue regime such as North Korea is not holding smallpox.

Nonetheless, no such threat has been verified. The Bush administration suspected Saddam Hussein of possessing smallpox and other biological weapons, but inspectors did not find any after the U.S. invaded Iraq in 2003.

Still, pressure to move quickly and spend more has helped shape U.S. biodefense policy since the Sept. 11, 2001, terrorist attacks and the anthrax mailings that fall. Bush, in June 2004, signed Project BioShield, a 10-year, $5.6-billion initiative to fund the development and stockpiling of medications to counter bioterrorism.

Two months later, New York based Siga Technologies, Inc. purchased the rights to what became known as ST-246 from a Pennsylvania company, ViroPharma Inc., for $1 million in cash and 1 million shares of Siga's common stock. Over the next three years, the National Institute of Allergy and Infectious Diseases awarded Siga two research grants and a related contract, worth a total of $23.5 million, to develop the new drug.

From the outset, there was only one potential customer: the U.S. government. Unlike the smallpox vaccine, which remains potent for decades, Siga's drug is guaranteed for only 38 months.

Siga's controlling shareholder is billionaire Ronald O. Perelman, one of the world's richest men. Perelman and others at Siga's affiliate, MacAndrews & Forbes, have long been major political donors. They gave a total of $607,550 to federal campaigns for the 2008 and 2010 elections, according to records compiled by the Center for Responsive Politics. About 65% of that money went to Democrats. Perelman donated an additional $50,000 to President Obama's inauguration.

[At some point (whether in this administration of the prior one is unclear from the story), the federal Department of Health & Human Services began a solicitation process to acquire a smallpox biodefense drug for those who may be unable to obtain the smallpox vaccine withing the 4 day window of that drug's efficacy.]

On Oct. 13, 2010, Siga announced that the government intended to award it a contract for ST-246 worth as much as $2.8 billion.

But the federal contract required that the winning bidder be a small business, with no more than 500 employees. Chimerix Inc., a North Carolina company that had competed for the contract, protested, saying Siga was too big.

Officials at the Small Business Administration investigated and quickly agreed, finding that Siga's affiliation with MacAndrews & Forbes disqualified it.

In early December, officials completed a required "justification for other than full and open competition," which said an antiviral against smallpox was needed within five years and Siga was the only company able to meet that timetable.

Because the contract was no longer to be awarded based on competition and because the only customer was the government, officials sought to assess whether the company's proposed price was "fair and reasonable," as required by federal law.

In so doing, officials looked at how much government money had already gone into developing ST-246. Public records show $115 million in federal support, not including the stockpile contract.

After reviewing Siga's costs and the prices of other drugs produced in low volumes compared with commercial products, the HHS negotiators wanted to pay about $170 for each treatment. The company argued for more based on ST-246's potential value to the nation.

A financial analyst for RBC Capital Markets reported to investors in May that the agreed-upon price per dose appeared to be $255. He arrived at that estimate by dividing the $433-million contract by the 1.7 million doses to be delivered. Siga told The Times that this would give a rough approximation of the per-treatment price.

"Siga did not derive its price based on any cost information, and, from Siga's viewpoint, such information is not relevant to determination of an appropriate price," the company's chief financial officer, Daniel J. Luckshire, wrote to Lurie's office and others on March 4.

"Siga has created extremely valuable intellectual property, embodied in ST-246, and Siga has priced ST-246 based on the value of that intellectual property," Luckshire added.

On April 6, Siga's chief executive, Dr. Eric A. Rose, emailed the government's chief negotiator, D. Andre Early, saying the two sides were "at impasse." Rose said "any further negotiation should occur with a more senior official [with] the authority to take into account the important policy issues that surround this procurement."

Negotiations over the price of the drug and Siga's profit margin were contentious. In an internal memo in March, Dr. Richard J. Hatchett, chief medical officer for HHS' biodefense preparedness unit, said Siga's projected profit at that point was 180%, which he called "outrageous."

In an email earlier the same day, a department colleague told Hatchett that no government contracting officer "would sign a 3 digit profit percentage."

In April, after Siga's chief executive, Dr. Eric A. Rose, complained in writing about the department's "approach to profit," Lurie assured him that the "most senior procurement official" would be taking over the negotiations.

On May 13, HHS announced what amounted to the second awarding of the contract, worth between $433 million and $2.8 billion, depending on whether the government exercised options to buy more of the drug in future years. Siga hailed it as a "historic event for the biodefense industry."

Siga was awarded the final contract in May through a "sole-source" procurement in which it was the only company asked to submit a proposal. The contract calls for Siga to deliver 1.7 million doses of the drug for the nation's biodefense stockpile. The price of approximately $255 per dose is well above what the government's specialists had earlier said was reasonable, according to internal documents and interviews.

The apparent procurement controversy in this acquisition, apart from the political one this story alludes to, concerns when cost (including the cost concept of "reasonable profit") is to be a determinate of price. Here, Siga argued cost is "not relevant to determination of an appropriate price"; rather, price should reflect the "extremely valuable intellectual property" embodied in the drug.

Guam law (based on ABA Model Procurement Code law), in very general terms, requires, when there is only one bid (as there always is in a sole source solicitation), that price cannot be accepted unless it is first independently determined that "the price submitted is fair and reasonable". (See, 2 GAR § 3102(c).) The regulations allow cost principles to be used to evaluate prices for sole source procurements (2 GAR § 7101(b)((1)(b)(i)), and the cost principles specified are extensive and detailed. The regulations require the use of federal government cost principles when dealing with contractors operating according to federal cost principles or when federal assistance monies are used and specified in the assistance program or instrument. (2 GAR § 7101(j).)

Federal price and cost principles are even more extensive and descriptive. The general policy of federal contracting, again, is that prices be "fair and reasonable". (FAR Subpart 15.402(a).) The full application of the FAR will not be discussed here (in deference to my limited acquaintance with it), but the general principles are set out in Subpart 15.4 ("Contract pricing").

The FAR distinguishes between price analysis and cost analysis, and describes the methodology for each analysis in detail. (See § 15.404-1 (b) and (c).) It described price analysis as "the process of examining and evaluating a proposed price without evaluating its separate cost elements and proposed profit." Cost analysis, on the other hand, "is the review and evaluation of the separate cost elements and profit in an offeror’s or contractor’s proposal ..., and the application of judgment to determine how well the proposed costs represent what the cost of the contract should be, assuming reasonable economy and efficiency."

The federal approach is to avoid looking to cost to evaluate fair and reasonable value as a general rule, subject to exceptions. The admonition is to use "every means available to ascertain whether a fair and reasonable price can be determined before requesting cost or pricing data". (§ 15.402(a)(3).)

The usual exceptions to the rule of avoiding cost data are based on the concept that where there is market value data available, usually in respect of "commercial items", or other "adequate price competition", that will be sufficient to establish a fair and reasonable value. (See, § 15.403-1(b).) But when those factors are lacking, a look at cost data can be justified.

An exception is also made for a waiver of cost price determination. "The HCA may consider waiving the requirement if the price can be determined to be fair and reasonable without submission of cost or pricing data. For example, if cost or pricing data were furnished on previous production buys and the contracting officer determines such data are sufficient, when combined with updated information, a waiver may be granted." (§ 15.403-1(c)(4).) Thus, this determination must be based on relevant facts and not some vague judgment.

There is also a policy and methodology for determining the profit allowed under a fair and reasonable price. As expected, it's complicated (see § 15.404-4). Policy statements of government interest reflect the reality that undue profit squeeze is not good as an incentive for good performance, not good for quality and not good for maintaining a viable competitive marketplace for government purchasing.

However, there are many factors the government is intended to consider in evaluating a fair and reasonable profit factor, including (pertinent, it would seem to the case above), the "contractor risk" and "independent development" factors.

Under the contractor risk factor, generally speaking, the more contract risk a contractor assumes to deliver the item sought, the greater the profit factor might be. Under the independent development factor, "the contractor may be provided additional profit opportunities in recognition of independent development efforts relevant to the contract end item without Government assistance. The contracting officer should consider whether the development cost was recovered directly or indirectly from Government sources." (See, § 15.404-4(d).)


It is not the point of this post to judge whether the profit factor was properly evaluated or even if cost factors should have been considered, whether the solicitation was appropriately sourced, or whether any other claim might be made about the procurement. Rather, it is simply to point out some of the broader procurement issues that must be addressed, over and above whatever political intrigue there may be. Procurement issues, also, are usually easier to define and assess than political intrigue or influence, so tend, for my money, to be more productive in dealing with something that doesn't pass a quick smell test.

It can also be pointed out that the government is not bound to take the price offered or leave it. In fact, as Jim Nagle's book, the History of Government Contracting, points out, there have been numerous instances in the federal government's procurement experiences when the government has created competition when there wasn't any, or coerced it upon manufacturers when it has been necessary to do so. And when politics has not intervened. These are all issues lurking in this story.

Friday, November 11, 2011

Procurement controversies -- Tanzania

MPs say No to 2nd hand purchases
Members of Parliament yesterday challenged the government’s intention to approve Section 66 of the new Public Procurement Bill, 2011 which, if given the nod by the House, will allow the State to purchase used airplanes, ships, railway engines wagons.

The Bill, presented in the House by the minister for Finance and Economic Affairs, Mr Mustafa Mkulo, among other things, focuses at improving and giving more powers to the Public Procurement Regulatory Authority (PPRA) to undertake its operations effectively.

The minister said the new Bill nullifies the 2004 Public Procurement Act, and the ministry in cooperation with the Parliamentary Committee for Finance and Economic Affairs and other stakeholders has gone through the Bill and decided to present it for more efficiency and better performance of the sector.

However, the opposition Finance and Economic Affairs deputy spokesperson, Ms Christine Lissu, challenged the Bill, saying the document was not well prepared to solve the problem. According to Ms Lissu, the document has failed to identify flaws that have forced the government to prepare a new Bill.

“The government has so far failed to tell us why it decided to formulate a new Bill to replace the Act. We want to see the weaknesses of the current law and not the strengths of the new Bill,” she said

Commenting on the government intention to purchase second- hand ships, airplanes, train engines and wagons, the opposition leader said the idea was alarming as it was likely to create opportunity for corruption. He said it was better to incur high costs for brand new machines instead of second hand, which are risky.

Mr Kigoda said the committee supports the idea of second hand purchases, but care should be taken lest Tanzania becomes other countries’ dumping ground.

Mr Kigoda said the purchase of machines and other materials under emergency should be done by the government when there was a state of war, health problems, fire outbreak and other things related to national security.


Now govt defends procurement of secondhand machines
The minister for Transport, Mr Omar Nundu, told Parliament purchasing secondhand machines suited Tanzania at the moment because many countries were applying the same strategy on costly machines such as planes, train engines and ships.

According to Mr Nundu, Kenya Airways sold a plane to a Canada-based airline in 2005. Kenya Airways had bought the plane in 2001. He added that British Airways, Ethiopian Airways and many other big companies in the world have been buying used planes from each other.The minister expressed suspicion that there were deliberate plans to prevent the Bill from passing due to individual interests.

Mr Nundu said all air transport companies in the country such as Precision Air, Fly 540 were operating used planes. He wondered why the idea was perceived dangerous when the government applied it.

Parliament is expected to conclude debating the Bill on Monday.

Sounds vaguely like the recent ambulance controversy here on Guam.

Penny wise and pound wiser?

The subject matter of the following articles coming from the UK is ferreting out procurement abuse. It makes the point that "routine" fraud (basically, "cheating") is usually more petty and easily ferreted out than the larger, more cleverly contrived fraud that undermines faith and confidence in both the procurement process and government more broadly.

It suggests that, on a cost benefit basis, it pays in many ways for government to focus its resources and tighten its regulations on the big stuff, and to demand greater accountability and culpability from those involved in such shenanigans.

£185m council fraud ''tip of £2bn iceberg'
England's councils unearthed £185m worth of fraud in 2010/11, an improvement of 37 per cent on last year's figure of £135m – money that could pay for around 700 libraries or the wages of up to 11,000 care workers – but the figures are just the tip of a £2bn iceberg, according to the Audit Commission.

The 'Protecting the Public Purse' report showed that 121,000 scams were detected in 2010/11, including false benefit claims, council tax discount cheating, and unlawful use of social housing.

The Audit Commission chairman Michael O'Higgins said: "Councils are certainly acting on fraud, and it is now firmly on the government agenda. But our latest survey of detection rates shows that we may be seeing just the tip of a very large iceberg.

"Now, for the first time, we are also able to publish details of fraudsters targeting care payments to the elderly and vulnerable. Also scams involving fraudulent student council discounts and fraud that goes to the heart of councils' multi-million pound procurement budgets."

He added: "We are all victims of fraud against councils. It is heartening to see councils making inroads, and improving detection rates in areas like council tax discounts. But they need to do more to tackle housing tenancy and procurement frauds."

Facing up to fraud, an opinion piece by Chris Clements, forensic and investigations services partner at Grant Thornton
The larger frauds, which potentially account for the missing £1.8bn, are most likely to be ‘off-book’ scams – harder to trace and dealing with far larger sums. This type of fraud would usually take the form of bribery and corruption, and as such would be unrecorded in the books and records, making it incredibly hard to detect. An example of this type of fraud might be a key figure in a public procurement taking a bribe to tip off bidders with insider tips about the tender requirements and\or other bidders.

Large-scale fraud is preventable through good quality controls and particularly an effective whistle-blowing policy. The majority of this type of criminal activity is spotted not by accountants, but by fellow colleagues who have noticed and reported unusual or suspicious behaviour.
With this in mind, the checklist below can help council employees to identify a fraudster.

1 An employee who has a lifestyle above and beyond what could be reasonably expected for their position. For example expensive holidays and expensive cars. And don’t forget close relatives, family and friends.

2 An employee who frequently circumvents controls. For example avoiding authorisation limits by processing one large payment as two separate payments. In local government we have seen this with people trying to circumvent procurement rules, including, in one case an attempt to employ a forensic accountant!

3 An employee who displays erratic behaviour. For example overly aggressive with colleagues, members of the public or suppliers.

4 The use of extreme disorder and confusion to cover up fraud. We have had examples of where the fraud started out as incompetence, but, once the member of staff realised that the incompetence could conceal extractive fraud, they continued using it as a technique to get away with thousands of pounds. The corollary of this is the control freak who wants to keep control of all transactions and never take holidays.

5 Frequent complaints from suppliers/others in the department/ members of the public. For example, suppliers complaining that they haven’t been paid whilst the accounting information indicates payment has been made. Members of the public insisting they have paid whilst the accounting information indicates that no payment has been received.

6 A refusal by a member of staff to delegate key tasks. For example doing the banking, performing control account reconciliations etc.

7 The frequent changing of supplier details, in particular bank details. Or duplicate bank details for multiple suppliers. This is a particularly common fraud at the moment and we have seen a number of public sector bodies defrauded out of amounts that have run into the millions.

Of course any one of the above, on its own, may not be a definitive indication of fraud, but they should be seen as red flags if combined with other concerns.

Wednesday, November 9, 2011

A look at the difficulties in writing specifications for services

Until the most recent very few decades, government purchasing was pretty much concerned with acquiring things, not services. Indeed, for the US, acquiring things was often a question of build or buy, and building was common from the earliest days of the pre-Revolution Union, particularly as regards arms and heavy equipment and transportation networks.

As an aside, the nation's use of its own armories to manufacture arms and create the machine tools for doing so, according to James F. Nagle, underwrote the industrialization of America. In his epic overview of the "History of Government Contracting", Nagle makes the point that the phrase "close enough for government work" began as a form of high praise, rather than derision as it is now used, because the government set the highest standards for precise manufacture of interchangeable parts. It's a truly enlightening book and a must read for any student of procurement.

But back to the story here, the trouble with much contracting has been in writing sufficiently detailed specifications to obtain what the government needs without unduly limiting the sources from which it can obtain it. (As Nagle pointed out, we have come a long way from the three page contract awarded to the Wright Brothers to produce the Army's first airplane.)

The problem with drafting effective specifications has been compounded by the recent trend towards a preponderance of contracting for services. As hard as it is to write effective specifications for things that can be measured for physical characteristics as well as performance qualities, the problem with writing specifications for services is almost vague by definition due to inability to objectively identify, quantify, measure and reward the subjectivity of service criteria. History shows that wherever subjective criteria are relied upon, favoritism creeps in.

Which brings me to the following economic study, which tries to bring some economic objectivity to an evaluation of municipal government contracting for services vs privatization, in-house vs outsourcing services. I get the sense that the study started with a bias toward privatization, but it is nevertheless instructive for its findings that show correlation, if not causation, between certain characteristics associated with build vs buy. It is also useful for showing how the relative difficulty in drafting specifications (and administering contracts based on them) affects decisions related to service (or supply, by extension) delivery mechanisms.

Given that the article discussed below focuses on municipal government contracting, it should have particular relevance for places like Guam and for places, again like Guam, which have adopted the ABA Model Procurement Code, a procurement model particularly intended for state and local procurement regimes.

The paper is "CONTRACTING FOR GOVERNMENT SERVICES: THEORY AND EVIDENCE FROM U.S. CITIES" by Jonathan Levin and Steven Tadelis, in THE JOURNAL OF INDUSTRIAL ECONOMICS. The authors are affiliated with Standford University and the University of California, Berkeley. Excerpts from the Introduction to the paper follow (footnotes omitted; refer to the article for more detail and explanation):
The debate [whether the private sector can provide a variety of public services more effectively than the government] has touched on services ranging from education, healthcare and transportation to trash collection and street repair. In addition to the normative question of what role government should assume in providing services [see, e.g., the discussion on "inherently government services" in this post], it has also raised the positive question of what determines government privatization decisions in practice.

We start with a simple model of procurement in which a government must arrange delivery of a service from an agent. The government can write a contract that specifies the time the agent must spend on the job and a set of performance requirements. Assume that specifying and enforcing a time requirement has minimal cost, but there are non-trivial costs to establishing and maintaining a set of performance requirements. Provided the government cares only about what is actually delivered, we show that an optimal contract must take one of two forms. The government either pays the agent for meeting a minimal time requirement or for meeting a performance requirement, but not both. These forms of contracting capture, in a rough way, the two most common ways that governments provide services: inhouse provision using salaried city employees and performance requirements contracts with private sector firms.

In our model, inhouse provision suffers from productive inefficiency due to the weak incentives of employees, but enjoys low contracting costs. In contrast, the productive efficiency of performance contracts comes at the cost of specifying and implementing performance requirements. This leads to predictions about how privatization decisions will vary across services. Services for which it is harder to write, monitor or adjust performance standards are more likely to be provided inhouse. The same will be true of services for which city administrators are more sensitive to the ultimate quality provided.

For obvious reasons, we cannot approximate a large-scale randomized research design that would allow us to quantify precisely how changes in contracting costs or city characteristics affect contracting practices. Rather what we can do is document broad patterns in contracting practices and relate them to our model and other ideas proposed in the theoretical literature.

Of course, a central prediction of efficiency based theories is that difficulties in specifying and administering performance requirements are likely to reduce privatization. To quantify these difficulties, we surveyed a set of city administrators, asking them to assess twenty-nine city services along a number of salient dimensions.1 We use this data to construct a measure of performance contracting difficulty.2

Our main empirical findings can be summarized as follows. First, services for which it is harder to write and administer performance contracts are less likely to be privatized. The effect is substantial. A one standard deviation change in contracting difficulty is associated with a change in the probability of being privatized of eight percentage points – that is, a forty percent reduction in the likelihood of privatization.

We also find that services ranking lower in terms of resident sensitivity to quality are more likely to be privatized.

Overall, our results indicate that a transaction cost view of privatization provides a useful framework for explaining local government contracting patterns. Notably, however, our results do not allow us to distinguish very clearly between the distinct sources of transaction costs that have been suggested in the theoretical literature. When we try to separate out problems with performance measurement, the potential for holdup, and the desire for control and flexibility, we find our survey measures of these problems to be so highly correlated across services as to be essentially impossible to disentangle.

In light of this, our view is that decomposing specific sources of transaction costs is likely to require more detailed data, most likely on contracting outcomes as well as choices.

The bulk of our analysis focuses on identifying city and service characteristics that are associated with privatization. We document that, controlling for the mix of services that cities provide, cities that do more private sector contracting spend notably less per capita.
The authors qualify that last observation with the following statement, which hopefully speaks more to their methodology than bias:
Though it is difficult to infer causality given the available data, the result is consistent with our modeling approach and suggests possibilities for future research.