It’s been over five years since the National Defense Authorization Act of FY 2012 (NDAA) began to reshape the landscape for government contracting executive compensation. The Department of Defense’s (DoD) portion of the government contracting industry was first to feel the impact of the NDAA. But the rest of the industry was also impacted by the Bipartisan Budget Act of 2013 (BBA) which effectively brought the same restrictions to all other executive agencies. The majority of the impact from the NDAA affected the DoD, National Aeronautics and Space Administration (NASA), and the Coast Guard beginning December 31, 2011. The BBA affected all other executive agencies beginning June 24, 2014.
Here are some of the major issues relative to executive compensation that are affecting contractors today.
The first is the new name. Executive compensation is now called contractor compensation and it applies to all contractor employees that contribute, directly or indirectly, to a government contract from top to bottom. Now that compensation limits apply to all employees, what does that mean for benchmarking? Keep in mind that these updated compensation requirements may apply to your first-tier subcontractors too, potentially impacting your bottom line if not adequately monitored.
Second, base compensation is not the only factor under evaluation. Bonuses and deferred compensation will also be scrutinized. The Government will attempt to calculate total compensation in developing its position and will apply assumptions to important factors if not otherwise specified.
And third, “Market data? What market data?” A frequent question asked by the Government is “where is the market data used to support your basis for an individual’s compensation?” The truth is that the market data they are looking for is usually not in your budget unless you are part of a larger organization.
As with most issues that may involve an audit, your best defense is documentation, documentation, documentation. Chances are you and your colleagues were hired before these acts were implemented and your compensation is only now coming into question. However, your organization has always been responsible for ensuring that any claim to the Government is reasonable at almost any point in time. Before June 24, 2014, the primary argument used by the Government against unreasonable compensation was Federal Acquisition Regulations (FAR) 31.201-3 — Determining Reasonableness. Now, it can also use FAR 31.205-6, Compensation for Personal Services, to address any perceived unreasonable compensation. This gives the Government more teeth, but it is also a double-edged sword. Understanding its drawbacks is the best way of protecting your organization’s (and the Government’s) interests.
Financial benchmarking is the primary tool used by the Government to determine whether your or your organization’s compensation values are aligned with the market. However, this should not be the only metric. The following should also be part of any compensation assessment:
- Experience in the industry
- Unique contract requirements
- Specific qualifications of individuals
- Publically-acknowledged performance (or Contracting Officer (CO) acknowledgment of exceptional performance)
The concept of total compensation can easily be misunderstood, so clearly identify what is part of total compensation:
- Define fringe benefits – organizational benefits that should be separately evaluated from an individual’s compensation
- Develop compensation plans that are consistent with the provisions of FAR Part 31.205-6
- Total compensation should be assessed on allowable costs only. Any costs that have been removed or otherwise questioned should not be considered
- Overtime and other differentials should not be applied toward total compensation
The absence of market data does not automatically result in questioned costs or reflect unreasonable compensation:
- Acceptance (final acceptance is even better) of the product or service is a fair assessment of the value obtained from the products provided or services rendered. After all, your contract is another data point in the marketplace
- Make sure that the market the Government has identified as your market is consistent with your determination
- If there are sufficient data points from your internal data, they can be used to support the fairness of the compensation
Two recent Armed Services Board of Contract Appeals (ASBCA) cases have supported the definition of allowable compensation. They should also be considered in planning and the determination of individual compensation:
- ASBCA No. 58966, March 29, 2017 – Deferred compensation including factors using a basis of Total Shareholder Return is expressly unallowable.
- ASBCA No. 60171, July 18, 2016 – Base compensation is not synonymous with compensation for working a regular 40 hour work week.
Finally, as much as they hate to admit it, the Government is not always right. It will do its best to understand your organization but often using as little information as possible. This leaves room for assumptions, misuse of grouping/categorization, and inconsistent understandings between your CO, who authorized and approved the work, and the individuals evaluating your compensation.
You may agree, completely or even in part, with the Government’s initial assessment to keep them happy but this may set precedence for your future evaluations. To alleviate this potential problem, ask for the Government’s documentation supporting its position. If the Government does provide its documentation, look for the following items:
- Consistency in its determinations including: benchmarking, market data, locality, labor category identification, and past determinations
- The Government’s consideration of unique aspects of your organization that differentiate you from your competitors
- Reliance on legally-rejected methodologies
What does CohnReznick Think?
These matters may not be present when decisions are made. Proper planning will help to avoid pitfalls by addressing them before they become problems years down the line or as they become relevant to the Government. At that point, it may cost significantly more to resolve the issue than taking preventative action early on.
If you need assistance with market data to support your position, or need help defending your contractor compensation claim in a draft audit response, we can help. The Government’s auditors (typically the Defense Contract Audit Agency) are not the final determination on reasonable compensation; it is your Contracting Officer. Contractor compensation is not black and white and, as a result, the better argument can win in negotiations.
CohnReznick appreciates the opportunity to help Government contractors identify potential solutions for various situations or challenges they may face. Toward that end, we have several resources you should look into:
- CohnReznick Insights (www.cohnreznick.com/insights): Provides CohnReznick’s latest insights on business trends, regulatory developments, and economic issues. You can subscribe to receive Insights e-newsletters by email.
- CohnReznick Website (www.cohnreznick.com): In addition to Insights, our website provides extensive information about all aspects of Accounting and Assurance, Tax, and Advisory services.
- CohnReznick GovCon360 (www.govcon360.com): Keeps you up-to-date on the ever-changing regulatory environment that is government contracting. From reference materials to educational presentations and thought leadership pieces on industry matters, GovCon360 is a valuable resource for the Government contracting professional.