Audit Questioned Costs and False Claims

I think we can all agree that a claim for payment submitted to the government, in relation to a contract, grant, or other arrangement, must be accurate and that such a claim represents that the claimant has upheld their end of the bargain.?

Luckily for fraud investigators, auditors regularly examine recipients of federal funds to identify internal control issues, unsupported or otherwise invalid claims, and other issues.? If analyzed correctly, these audit findings can potentially lead to new criminal and civil fraud investigations, most commonly Civil False Claims Act (FCA) cases.?

This article will highlight a few salient details to help oversight, compliance, and other professionals better understand the relationship between a questioned cost and a potential violation of the FCA or another fraud related statute.?

Questioned Costs

According to 2 CFR § 200.84, also known as the Uniform Grants Guidance, “Questioned cost means a cost that is questioned by the auditor because of an audit finding:

(a) Which resulted from a violation or possible violation of a statute, regulation, or the terms and conditions of a Federal award, including for funds used to match Federal funds;

(b) Where the costs, at the time of the audit, are not supported by adequate documentation; or

(c) Where the costs incurred appear unreasonable and do not reflect the actions a prudent person would take in the circumstances.

(For further information on the audit process and questioned cost, see the U.S. General Accountability Office’s Generally Accepted Government Auditing Standards (GAGAS), also known as the Yellow Book. https://www.gao.gov/yellowbook )

The Federal Acquisition Regulation 31.201-2 states, “A cost is allowable only when the cost complies with all of the following requirements: 1) Reasonableness. (2) Allocability. (3) Standards promulgated by the CAS Board, if applicable, otherwise, generally accepted accounting principles and practices appropriate to the circumstances. (4) Terms of the contract. (5) Any limitations set forth in this subpart.”

Another way to think about questioned costs is that one or more of four conditions are met:? it is unreasonable, unsupported, unallowed, and/or it is unallocable.

Unreasonable:? The FAR states: “A cost is reasonable if, in its nature and amount, it does not exceed that which would be incurred by a prudent person in the conduct of competitive business. Reasonableness of specific costs must be examined with particular care in connection with firms or their separate divisions that may not be subject to effective competitive restraints. No presumption of reasonableness shall be attached to the incurrence of costs by a contractor. If an initial review of the facts results in a challenge of a specific cost by the contracting officer or the contracting officer’s representative, the burden of proof shall be upon the contractor to establish that such cost is reasonable."

Unsupported:? there are insufficient or nonexistent records or other information to demonstrate that the cost is valid.? For example, a $50,000 expense related to an event, but there are no clear records of how the entity determined that $50,000 was a fair price and there is no information about the specific breakdown of this cost or the nexus to the funded program.? ??

Unallowed: a cost that is expressly prohibited in the agreement between the government and the recipient such as lobbying, certain legal expenses, expenses incurred outside the programmatic scope or before the award date.? For example, an entity used government funds for travel to Washington, DC for individuals to spend a day lobbying elected officials for additional funding. (Note: this might a legitimate organizational use of funds, but it cannot be charged to a federal award).?

Unallocable: a cost that cannot be attributed to the funding program such as an expense incurred that benefits multiple programs.? In these scenarios, an organization might lack a cost allocation plan or apply it improperly.? Indirect cost rates typically come into play in these situations.???

As you might imagine, given the above criteria, an audit of a large complex government contract or grant could result in questioned costs anywhere from zero to tens or even hundreds of millions of dollars.

The False Claims Act

One of the federal government’s most potent tools to address fraud and some other types of improper payments is the FCA, 31 USC § 3729.

The FCA is aimed at addressing unscrupulous individuals and entities who claim funds they do not deserve from the government.? The statute is triggered when a person or entity is found to have knowingly presented or caused to be presented a false claim.? The law defines “knowingly” as having actual knowledge of the falsity, acting in reckless disregard of the truth, or acting with deliberate ignorance of the truth. Those found liable under the FCA can be subject to up to treble damages and penalties of $13,946 to $27,894 per claim.

For example, suppose an entity presented $10,000 in monthly claims to the government over a five-year period for expenses that proved to be false, because the employees did not exist or because they worked on projects outside the scope of the government agreement.? Let’s also assume that the government has solid evidence that the entity had clear knowledge that their claims were false.

FCA liability could look something like $10,000 x 12 months x 5 years = $600,000 in damages or overpayments.? Treble damages are then $1,800,000 and penalties could be as high as 60 claims x $27,894 = $1,673,640.? This equates to total potential liability of $3,473,640.? And remember, the total false claims, or single damages, for the labor charging issue were $600,000.?

As with all civil statutes, the burden of proof in FCA cases is “preponderance of the evidence”, not the higher “beyond a reasonable doubt” standard for most criminal violations.? If the evidence supported that the above example was part of a scheme by a bookkeeper to steal the $600,000 and there was sufficient evidence to prove that beyond a reasonable doubt, then the matter might also be pursued as a criminal case.?

There is much more to know about the FCA, including government knowledge issues, objective falsehood and materiality requirements, civil investigative demands, qui tam relators, etc., but for the purposes of this discussion, the key point is that there is potential liability for submitting false claims.? (There are of course other civil and criminal laws, including a criminal false claim statute, that can apply to these situations, but the FCA is far and away the most commonly used tool for these scenarios.)

The language of the FCA offers flexibility about what makes a claim false.? For example, FCA liability may exist if:

• a hospital bills Medicare for services not provided or for services provided by an unqualified nurse or unaccredited lab;
• a vendor submits an invoice to a government agency which implicitly certifies that they have complied with all cyber security standards, when in fact their computer network is not password protected, they are not current on software security patches, or they have ignored previous reports that identified flawed cybersecurity practices;
• a recipient of grant funds requests reimbursement for costs related to no-bid contracts when the award agreements required full and open competition; there is no evidence of any sole source waivers; or
• a construction company provides materially substandard work and then submits a claim certifying that they met all contractual requirements.?

Intersection of Questioned Costs and False Claims

Every audit questioned cost is a potential FCA case.

If an auditor collects records and interviews people and finds that a claimed cost is unallowable, unsupported, and/or unallocable, or otherwise meets the above criteria in 2 CFR § 200.84 or the Federal Acquisition Regulation § 31.201-2, a natural next question should be whether the claim also violated the FCA or another statute.?

It is important to remember that the audit process is structured and collaborative in the sense that if auditors have concerns or questions during an engagement, they provide the auditee opportunities to explain the issue and provide adequate supporting documentation.? In other words, an audit questioned cost is not simply the result of an auditor saying that when “they looked in the file they could not find support” or that the records were merely disorganized.

A questioned cost is the result of a formal back and forth from which the audit team, and often several layers of audit managers, conclude that based on the available information, the cost meets the above definitions of a questioned cost.?

Analyzing Questioned Costs as Potential FCA Violations

Fraud investigators should work closely with auditors, ideally before a report becomes public, to discuss potential questioned costs and to consider if there might be a potential FCA or other case.

Specifically, below are a few steps to consider taking:

• Thoroughly review the draft or final audit report to help identify and frame the specific potential FCA issues and determine the timeframe involved—did this occur for a month or eight years?
• Determine specifically why the cost is questioned.? For example, is it because timesheets are missing a supervisor’s signature?? If so, have we validated if those individuals exist and if they worked on this specific project?? Do we have any evidence that the people do not exist?? In other words, is this possibly a “technical foul” process issue or is there information that the government did not receive the work they paid for?? If the concern relates to a claimant’s failure to comply with a term or condition of an award, what exactly was the requirement?? Is compliance measured objectively or subjectively?? Is there evidence that the claimant knew of the falsity or that they should have known??
• Meet with the audit team to explore the details behind the evidence, any assumptions, and the history and prevalence of this issue with this entity or across all similar entities (i.e. is this common problem in this type of government award?)
• Interview the contracting or grant officer or other appropriate officials to obtain their perspective on the issue.? Were they aware of it, did they issue a waiver or otherwise approve of the cost, is this issue “material” to payment of the claim?? ?
• Begin to consider a rough damages methodology.? What did the government lose due to these invalid claims?? Has this conduct caused additional secondary losses to the government such as the need to hire engineers or make repairs on a construction site? What did the recipient receive that they were not entitled to receive??How many claims were false?
• Organize and document what you’ve found. Create a timeline, clearly lay out what was expected / required by the government agreement, what actually happened, the damages, and why it matters.?
• Talk to the U.S. Department of Justice’s Civil Division, a local U.S. Attorney’s Office, and/or the U.S. Department of Justice’s Antitrust Division as appropriate to determine their interest in the matter.?
• Keep audit colleagues informed of your findings and planned next steps.?

Go Forth and Conquer...

Government audits regularly make formal findings including those related to questioned costs.? This information can be valuable predicate for a potential FCA or other case.? Go read some audits— you might unlock some valuable information. ?