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Project on Government Oversight

POGO's letter to OMB about Taxpayer Funded Executive Compensation

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April 22, 2010

Honorable Peter Orszag   
Director     
Office of Management and Budget      
Eisenhower Executive Office Building 
Room 252     
Washington, DC  20503   

Dr. Jared Bernstein
Assistant to the Vice President for Economic Policy
Eisenhower Executive Office Building
Room 224
Washington, DC  20501

Via Facsimile
 
Dear Director Orszag and Dr. Bernstein:

The Project On Government Oversight (POGO) is an independent nonprofit that investigates and exposes corruption and other misconduct in order to achieve a more effective, accountable, open, and ethical federal government. As such, one of POGO’s areas of focus is contracting oversight. Accordingly, POGO is concerned when contractors are reimbursed for compensation costs that are excessive, particularly in light of the current economic conditions and the Administration’s focus on establishing executive compensation guidelines with reasonable limits.

As you may be aware, on April 15, 2010, the Office of Federal Procurement Policy (OFPP) published its annual benchmark compensation limitation for certain contractor executives.  This benchmark—$693,951—is the maximum allowable compensation that will be recognized under government contracts for pricing and/or reimbursement purposes during contractors’ fiscal year 2010.[1]

First, POGO would be remiss if we did not express our dismay at the nearly $700,000 per annum cost allowability ceiling. We realize that the formula for establishing this “benchmark” is statutory. Nevertheless, it is an example of the outrageous influence government contractors possess to permit such an enormous amount of compensation to be reimbursed by taxpayers. We urge you to examine administrative and regulatory mechanisms to limit these costs. POGO takes no issue with high levels of contractor employee compensation, provided that such compensation is not built into the cost structure for which the government must pay through contract pricing or reimbursement rules.

Furthermore, although POGO realizes that OFPP is required by Section 39 of the OFPP Act, 41 U.S.C. § 435 to establish an annual benchmark executive compensation limitation applicable to the top five executives at each home office and segment of a government contractor, we believe that this allowability restriction is far too limited in its application under existing Federal Acquisition Regulation (FAR) cost principles, specifically FAR 31.205-6(p). The rule is also inconsistent with the actions of the Administration to limit executive compensation in the financial sector, and results in the government paying excess costs on contracts. Specifically, POGO urges the Office of Management and Budget, through the Federal Acquisition Regulatory Council, to extend the current FAR rule to limit allowable costs for all contractor employees whose compensation is charged either directly or indirectly to government contracts to the amount specified under Section 39 of the OFPP Act, and not just to the top five executives at each contractor home office and segment location. The current narrowly written rule favors contractors and passes on to taxpayers, as an allowable cost, compensation in excess of $693,951, so long as the individuals’ whose compensation is so charged are not among the top five covered executives of either the home office or operating segment of the contractor.

Contractors performing government contracts are reimbursed for their allowable, allocable, and reasonable compensation under FAR 31.205-6, Compensation for personal services. (See 48 CFR, Chap 1, Sec. 31.205-6.) Section (p) limits the allowability of compensation for the top five senior executives at contractor home offices and segments. The limitation is determined annually by OFPP and represents the median amount of compensation provided for senior executives of publicly-owned U.S. corporations that have annual sales in excess of $50 million for the fiscal year.

POGO believes the compensation allowability ceiling should be applied to the compensation of all contactor employees, not just the top five at each contractor home office and segment location. Under the current method of applying the benchmark to the top five executives, all other executives and employees may price or be reimbursed compensation costs much greater than the benchmark established by OFPP. In such difficult economic times, it does not make sense to reimburse contractors at an amount higher than the benchmark amount merely because they are in a position other than the top five. Moreover, it is difficult to understand why a cost reasonableness standard applying to the top five executives does not apply to all employees. Why would allowable compensation for employees below the top five be at a higher amount than allowed for the top five employees?

POGO believes that by using the median compensation received by executives in the prior fiscal year, there is little incentive for contractors to control the compensation paid to executives. Ultimately, the government, and consequently taxpayers, pay executive compensation of contractors through pricing and reimbursement under government contracts. As greater compensation is paid each year, the next years’ benchmark increases as a result. In 1995, the allowable compensation amount for Department of Defense contracts was $250,000.[2] In 1997, Section 808 of P.L. 105-85 established the current benchmark compensation methodology. As a result, the OFPP established the benchmark at $340,650[3] for contractor fiscal year 1998. Since 1998, the benchmark compensation amount has more than doubled to $693,951.

Although the methodology for determining the benchmark may be statutorily based, we see no reason the FAR cost principle should not be extended to cover all contractor personnel, not just the top five executives. Contractors will still be free to pay their executives and other personnel whatever compensation they desire. However, there is no reason for the government, and consequently taxpayers, to have to recognize these costs for contract pricing and reimbursement purposes. In fact, as pointed out in OFPP’s own study of the matter in 1997, most contractor personnel whose compensation is in excess of $250,000 are being paid that much because of various financial incentives the employees are meeting. Such incentives are not a product or service cost in the traditional sense, but are a form of profit or equity sharing. To allow what is effectively a form of profit or equity sharing to be built into the cost structure of government contracts for pricing or reimbursement purposes leads to a perverse incentive system. With the current benchmark approaching $700,000 per annum, at the very least, the FAR compensation allowability restriction should be extended to all contractor employees.

The recent increase in the allowability of compensation costs priced or reimbursed under government contracts could not come at a worse time. It is a continuation of the “business as usual” mindset that has come to plague government contracting. Cost overruns and over billings on government contracts have become too common-place. The Joint Strike Fighter program is significantly over budget. War-related contracts are rife with abuse and excessive costs. The extension of the current executive compensation cost allowability restriction to all contractor employees is a small step in the right direction.

POGO understands that some may argue that section 39 of the OFPP Act necessarily restricts application of the existing cost principle at FAR 31.205-6(p) to only the top five executives. In our view, this is the minimum the cost principle requires. Just as the FAR cost principles were recently proposed to be amended to treat as unallowable the costs of any activities undertaken to persuade employees to exercise or not exercise the right to organize and bargain collectively, 75 FR 19345 (April 14, 2010), so does the FAR Council have the authority to extend the application of the existing compensation cost principle. In fact, the majority of FAR cost principles are a matter of administrative discretion and have no statutory basis for their promulgation.

Accordingly, we urge you to end this FAR regulatory loophole which permits the charging of excessive compensation by contractors by removing the “top five” executive limitation pertaining to the FAR 31.205-6(p) cost principle.

Sincerely,

Danielle Brian
Executive Director 

[1] 75 FR 19661, Determination of Benchmark Compensation Amount for Certain Executives, April 15, 2010.

[2] DFARS 231.205-6(a)(2)(i)(A) (1995).

[3] FAR 31.205-6(p) in existence (1998). 

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