Internal investigations: accounting for in-house costs.

Companies conducting internal investigations face many sensitive, complex legal, regulatory and business issues. Confronting employee misbehavior is not easy. Coordinating in-house resources and outside legal and consulting professionals to gather facts, determine cost impact, examine legal implications and determine an appropriate course of action is especially challenging.

It also can be expensive. For government contractors, direct costs of an investigation and costs to implement any resulting remedial measures may be hard to recover. This article examines the treatment of certain costs for an investigation and related corrective measures under the Federal Acquisition Regulation ("FAR"), and distinguishes those in-house costs that may be recovered from those that may not.

FAR Part 31 contains cost principles and procedures for pricing contracts, subcontracts and modifications where cost analysis is performed, or a contract clause requires the determination or negotiation of costs. The cost principles define general concepts related to the recovery of incurred costs, such as allowability, reasonableness and allocability. They also provide specific rules regarding the treatment of a multitude of selected costs. Among these selected costs, two types are particularly relevant to internal investigations: (1) costs related to a proceeding that includes an investigation and a determination of present responsibility or suspension or debarment, and (2) costs related to "fines, penalties, and mischarging."

Any internal investigation of possible wrongdoing that may give rise to criminal or civil liability likely will consume countless hours by corporate staff collecting, producing and analyzing data, and other investigation-related support. A cost impact analysis and determination can consume significant company resources. Costs associated with immediate remedial measures, such as developing and strengthening ethics and compliance program components including codes, policies, procedures and training to meet minimum FAR Part 9 standards governing contractor responsibility also may be significant.

Under FAR 31.205-47, costs relating to certain legal proceedings are unallowable in specified circumstances. This cost principle makes unallowable costs related to any proceeding brought by a federal, state, local or foreign government for violation of law by the contractor (including its agents or employees) if the result is a conviction or a finding of contractor liability involving an allegation of fraud, suspension or debarment proceedings, rescission or voiding of a contract, or default termination for failure to comply with a law or regulation.

Under the "legal and other proceedings" cost principle, proceedings include investigations. Thus, internal costs related to such investigations are not allowable. Costs covered by this cost principle include administrative and clerical expenses, and costs of employees, officers and directors, (including in-house counsel).

The DCAA Contract Audit Manual lists salaries and related fringe benefits, as well as the costs of secretarial and other support services; space, utilities and library services, as types of in-house investigation costs that are unallowable and should be segregated. The Audit Manual states that "any in-house support costs (particularly in the legal and accounting departments) incurred for unallowable types of proceedings should ... be segregated."

FAR 31.205.15 bars recovery of costs related to mischarging of costs on Government contracts. This includes costs incurred to measure or otherwise quantify improper charging, and to remedy or correct the mischarge. Directly related in-house efforts such as reconstructing or restating general ledger data also fall within this provision and cannot be recovered through government contracts directly or indirectly.

Costs of outside counsel or accountants retained to investigate a suspected fraud or to remedy mischarges to the government are clearly unallowable and must be segregated.

Costs of prophylactic measures are murky. Typically, costs of self-governance programs, such as compliance efforts, codes of ethics and forward-looking audit procedures, are allowable expenses. But when a fraud or other investigation is involved, whether such costs are "related to" the investigation as "remedial" costs, or are otherwise allowable business expenses may be unclear.

One solution is to create bright-lines or dates to establish when, for example, adjusting journal entries necessary to address the cost impact of mischarging is completed, or when initial training on a remedial ethics code or policy is completed. The federal circuit has given the term "proceeding" a broad meaning that encompasses "all acts and events between the time of commencement and the entry of judgment." So, caution is advised, particularly when settling fraud issues and negotiating administrative agreements in lieu of suspension or debarment proceedings.

Of course, having a robust effective ethics and compliance program in place prior to an investigation would minimize both the cost-recovery issue and the risk that such an investigation would be necessary in the first place. Nevertheless, as soon as wrongdoing or mischarging is suspected, in most instances, a separate charge number should be established and personnel working on the investigation should track their time and account for it under that number.

For some companies, segregating time by salaried employees on discrete tasks cannot be done. In such cases, estimates and extrapolations, which meet certain criteria, may be permitted. A pro-active approach will permit easier resolution of cost allowability issues once the legal issues are resolved. These FAR cost rules reinforce the importance of corporate-level ethics and compliance principles and practices, including the development of best practices within the finance and accounting systems, and the need for established procedures to ensure prompt, accurate and timely recording, and reporting of transactions and disposition of assets in reasonable detail.

NDIA ETHICS COMMITTEE 

John D. Illgen

Vice President, Northrop Grumman Simulation Technologies Corporation

Tofie M. Owen Jr.

Senior Vice President for Corporate Development, SAIC 

James L. Pierce

Consultant (Former Chairman & CEO, ARINC Inc.)

Thomas W. Rabaut

President, BAE Systems Land and Armaments 

Joe R. Reeder, Esq.

Attorney, Greenberg Traurig LLP 

Lawrence A. Skantze 

Gen., USAF (Ret.)

W. John Stoddart

Executive Vice President and President Defense, Oshkosh Truck Corporation

William Usher

Maj. Gen., USA (Pet.), President, National Correlation Working Group

TRUSTEES

Dr. Vincent J. Ciccone

President & CEO, RASco Inc.

Mary E. Lacey

Program Executive Officer, National Security Personnel System

James McAleese

Principal, McAleese & Associates

Lewis A. Palumbo

Senior Vice President, U.S. Business Development,

Raytheon Company

Mike Fayad and Dave Hickey are attorneys at Greenburg Traurig based in Washington D. C. & Tyson's Corner, Virginia.