On July 29, 2015, the Office of the Inspector General for the Department of Defense published on its website new “Contract Audit Fraud Scenario and Indicators for Material Pricing Deficiencies in a Postaward Audit.” While this tool – and several others posted on the Defense IG’s website – is designed to be used primarily by Defense Contract Audit Agency (DCAA) auditors to identify possible fraud, it also provides valuable insight for government contractors subject to DCAA audits. By knowing the indicators of fraud that government auditors are looking for, contractors can be better prepared for further inquiry and investigation if the facts and circumstances of their postaward audit raise these types of “red flags.” Further, many of the fraud scenarios and indicators that DoD IG identifies are of a general nature and could be found in any type of audit.

Criminal Investigators May Find Other Liabilities

In a postaward audit to determine if materials were defectively priced, the government’s auditors are alert to circumstances that might indicate fraud, thus requiring them to make a referral to a criminal investigator. The result could be further investigation that exposes the company to criminal, civil and/or administrative liability. The IG identifies 11 fraud indicators that DCAA auditors should be on the lookout for in defective pricing audits. The first six relate to the facts and circumstances of the specific award being audited:

• a significant variance between proposed and negotiated vendor/subcontract quantities or prices
• use in contract performance of different vendors or subcontractors than proposed
• contractor using higher budgetary/planning quotes to support proposal or negotiations knowing that lower firm quotes have or will be submitted on request
• contractor using higher courtesy bids to support proposal or negotiations knowing that lower bids are or will be available; courtesy bids also increase the lowest bid
• failure to disclose the existence of a decrement factor, purchase discount, or historical negotiation experience with vendors
• specific knowledge that is not disclosed regarding significant cost issues that will reduce the proposed cost

The DoD IG’s list of fraud indicators goes on to include circumstances that take into consideration the company’s conduct in matters beyond the specific award, and even how they responded to questions raised during the audit. These fraud indicators are:

• consistent failure to update submitted cost or pricing data prior to agreement on price
• repeated defective pricing involving similar patterns or conditions
• continued failure to make complete disclosure to the government of data known to responsible personnel
• denial by responsible contractor employees of the existence of historical or other records that are later found
• continued failure to correct known business system deficiencies that impact or allow for submission of proposal data that is not accurate, complete or current

DoD Instruction 7600.02 Requires Fraud Investigation Referral

When DCAA auditors discover an indication of potential fraud, they are required by DoD Instruction 7600.02 to make a referral to the appropriate investigative agency. While the DoD IG guidance asks auditors to “use their best judgment” and “when in doubt, make a referral,” there may be opportunities during an audit for an informed contractor to recognize the “red flags” and present evidence demonstrating that fraud did not occur. Knowing the indicators an auditor is assessing can help contractors avoid finding themselves under criminal investigation for fraud as a result of issues that arise during a postaward audit.