Trying to Put a Cap on It - Yet Again: Another Attempt to Limit Government Reimbursement of Contractor Executive Compensation

This post was written by Lorraine M. Campos, Christopher L. Rissetto and Leslie A. Monahan.  

Back in February 2012, the Obama Administration asked Congress to reform the current reimbursement formula for federal government contractor executives. Specifically, President Obama sought to cap the executive reimbursement at the same level as what the government pays its own executives – $200,000 per executive. Although last year’s request may have fallen on deaf ears, more than a year later, debate over reimbursement for executive compensation remains a hot topic.

The White House is once again pushing for lower contractor compensation caps. According to the Office of Management and Budget's newest blog post, the Obama Administration will ask Congress to tie the federal government contractor executive reimbursement limit to the president's annual salary, which is currently $400,000. OMB stated that this proposal “provides a reasonable level compensation for high value Federal contractors while ensuring taxpayers are not saddled with paying excessive compensation costs."

The Obama Administration understands that while the proposed limit saves taxpayers’ money, all contractor skills are not created equal and there may be appropriate reasons for exceeding the limit. Accordingly, the proposed new plan provides an exemption for allowing additional reimbursement when specialized skills must be utilized to support missions. Further, there would be no cap on what federal contractors could pay their own executives. Rather, the only restriction would be on what the government could reimburse federal government contractor executives.

Although the prior proposal failed to be made into law, there is still support for this issue in Congress – especially given the government’s current financial constraints. However, critics of the proposal remain on both sides. On one hand, organizations like the American Federation of Government Employees argue that this proposed cap does not do enough. Others, like the Professional Services Council, argue that if implemented, federal contractors will lose their ability to attract top talent and the government will ultimately suffer as a result. Only time will tell if the White House can claim success on this issue or if it will need to try yet again to put a cap on this reimbursement issue.

Government Contractor Successfully Defends Its Senior Executive Compensation Costs

This post was written by Stephanie E. Giese.

The issue of senior executive compensation limits continues to be a contentious one for the federal government and its contractors. This may explain why the limit has not been raised since 2010 from the current amount of $693,951. In fact, the Obama administration has proposed lowering senior executive compensation limits to $200,000, the level it caps salaries for its own executives. Given the administration’s focus, this is an area where we are likely to see more litigation. The Appeals of J.F. Taylor, Inc., ASBCA Nos. 56105, 56322 (January 18, 2012) (“JFT”) is an example of such litigation that was recently decided in favor of the contractor.

The JFT decision is relevant to contractors subject to Federal Acquisition Regulation (“FAR”) 31.205-6(p), the federal limitation on the allowability of compensation for senior executives. This benchmark limitation is the maximum amount a contractor may seek reimbursement for under its government contracts, but does not limit the compensation an executive may earn. Further, the limit that applies to small-to-midsize government contractors may actually be lower than the benchmark limitation. Regardless of the size of the contractor, a contractor subject to FAR 31.205-6(p) must show that the executive compensation costs it charged the government are reasonable in order for the government to reimburse those costs. To evaluate reasonableness, Defense Contract Audit Agency (“DCAA”) conducts a statistical analysis considering factors such as industry, company revenue relative to other companies in the same industry, geographic location, and the executive position being evaluated.

The JFT decision offers arguments that may allow a contractor to resolve disputes with DCAA in annual Executive Compensation Reviews (“ECRs”) and to avoid potential litigation. In its JFT decision, the Armed Services Board of Contract Appeals held that DCAA’s methodology was “fatally flawed statistically”:

(a) as a matter of basic statistical analysis,

(b) because the method market priced JFT’s executive compensation at the median without adequate consideration of the company’s superior performance,

(c) because DCAA failed to evaluate the compensation of the JFT vice presidents based on the revenues of the whole company even though each vice president had companywide responsibilities for the success of the company, and

(d) because the method used does not yield auditable and reliable results.

Thus, JFT was not required to repay the government approximately $600,000 in disallowed executive compensation costs. A contractor should consider the fatal flaws cited by the Board as potential arguments to defend its own executive compensation costs.

Are Government Contracts Executives Overpaid?

This post was written by Leslie A. Monahan.

Last week, the Office of Management and Budget (“OMB”) announced that President Obama is working to breathe life back into a proposal to end federal contractor executive overpayment. According to the OMB’s blog post, the Obama administration will be asking Congress to reform the current reimbursement formula for contractor executives. The proposal will not limit how much contractors can pay their top five executives. Rather, it aims to limit the amount the government can reimburse contractors for executive salaries. Specifically, the proposal seeks to cap the government’s reimbursement at the same level as what it pays its own executives – $200,000 per.

Back in the 1990s, Congress tied the levels of pay given to contractor executives to the salaries of the nation’s top private executives, as opposed to government executives. As private sector salaries soared, so did those of contractor executives, something that did not go unnoticed. Receiving support from senators on both sides of the political spectrum, an amendment to the 2012 Defense Authorization Bill capped the reimbursement of salaries for some contracts with the Department of Defense. The Obama administration now seeks to extend the provisions across all government agencies as part of its Campaign to Cut Waste.

While the Obama administration believes that ending executive overpayment will benefit all taxpayers, certain taxpayers disagree. On the same day OMB made its announcement, the Professional Services Council (“PSC”) publicly opposed the measure. PSC stated that the proposal would negatively impact small businesses and inhibit the ability of the government and industry to attract top talent to work on federal contracts.

SEC Rejects Proposal by its Enforcement Staff to Settle Landmark 'Clawback' Suit

This post was written by James A. Rolfes.

Last week, the Washington Post reported the SEC had rejected a proposed settlement of SEC’s landmark case seeking enforcement of the so-called “clawback” of executive compensation under Sarbanes Oxley Section 304. See Hilzenrath, D., Washington Post July 20, 2011, SEC Rejects Proposal. In SEC v. Jenkins, No. 09-cv-01510 (D. Ariz. filed Jul. 22, 2009), the SEC for the first time sought over $4 million in incentive-based compensation from an admittedly non-culpable CEO of a company that had misstated its financial statements due to employee fraud. The SEC further had obtained an early victory in that case, persuading the federal court that SOX 304 did not require a showing that the defendant CEO aided or even knew about the fraud leading to financial statement restatement. SEC v. Jenkins, 718 F. Supp. 2d 1070 (D. Ariz. 2010). Now the Commissioners have rejected the settlement recommendation of the SEC enforcement staff and accepted the risk that trial of the matter could undo this victory -- signaling perhaps the Commission’s intention to aggressively pursue clawbacks.

Behind the scenes, however, the rejection of the settlement provides a less clear message. According to unnamed sources, some Commissioners balked at a settlement that obtained less than half the sought-after compensation, but others rejected the staff’s recommendation claiming the SEC should never have brought the case in the first place. That tension reflects a wider debate now on going as to whether SOX 304 enforcement against “innocent” CEOs and CFOs represents an intended tough Congressional mandate to punish executives who oversee the filing of later-restated financial statements, or a poor policy choice by the SEC. See e.g., Harvard law School Forum on Corporate Governance and Financial Regulation.

That divergence of Commissioner opinion may also play out as the SEC undertakes to establish rules required under Dodd-Frank 954. That legislation mandated expanded restatement-based clawback requirements, and directed the SEC to craft rules requiring public companies to recover incentive-based compensation calculated using erroneous financial data. See Dodd-Frank Leaves Clawback Uncertainty, Compliance Reporter (August 30, 2010) Rolfes, J.  Right now, the SEC has placed that rulemaking responsibility on hold at least until the Fall 2011.