oversight

Observations from NEON Audit 15-1-001 (November 24, 2014)

Published by the National Science Foundation, Office of Inspector General on 2014-11-24.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                       National Science Foundation
                                           4201 Wilson Boulevard
                                          Arlington, Virginia 22230


Office of Inspector General


MEMORANDUM

DATE:              November 24, 2014

TO:                Jeffery Lupis, Director
                   Division of Acquisition and Cooperative Support (DACS)

FROM:              Dr. Brett M. Baker
                   Assistant Inspector General for Audit

SUBJECT: NSF OIG Audit Report No. OIG-15-6-001, Observations that Warrant NSF’s
         Attention Found during Audit on National Ecological Observatory Network, Inc.

We contracted with the Defense Contract Audit Agency (DCAA) to complete an audit of
National Ecological Observatory Network, Inc.’s (NEON) accounting system. The purpose of
this audit was to determine if NEON’s accounting system is in compliance with grant terms. As
part of this audit, DCAA issued two reports: a letter with observations and recommendations
concerning NSF’s grant policies and guidance to awardees, attached to this memo; and an audit
report with a recommendation regarding NEON’s practices, issued in a separate transmittal. 1

Background

DCAA provides services in connection with negotiation, administration, and settlement of
awards to ensure taxpayer dollars are spent on fair and reasonable prices. In 2012, DCAA
audited NEON’s construction proposal budget. 2 DCAA rendered an adverse opinion on NEON’s
proposal since the audit disclosed significant questioned and unsupported costs of $154.4 million
(nearly 36% of the proposed $433.7 million budget). Of the total exception amount of $154.4
million, $72.6 million (47%) were questioned contingencies. In February 2013, we contracted
an accounting system audit because of the significance of the findings in that report.

Summary

As part of the NEON accounting system audit, DCAA issued Observations that Warrant
Attention of the NSF-OIG and provided recommendations in three areas (Contingency
Expenditures, Management Fees, and NSF Policy on Reporting Fraud, Waste and Abuse) to help
NSF improve its management controls and to protect taxpayer dollars. The observations and
recommendations for OIG’s consideration are described below.


1
  NSF-OIG Report No. 15-1-001, Independent Audit Report on National Ecological Observatory Network, Inc.’s
Accounting System, dated November 20, 2014
2
  NSF-OIG Report No. 12-1-008, Audit of NEON, Inc.’s Proposed NEON Construction Budget, dated September 28,
2012
                                                             NSF OIG Audit Report No. OIG-15-6-001


Contingency Expenditures

DCAA concluded there is a need for NSF to improve safeguards and accountability over the
significant contingency funds included in NSF awards. DCAA audits have found that
contingency costs are estimated based on percentage factors, yet are not supported by
accounting, statistical, or other relevant data, nor by a process to accumulate actual costs for
comparison with such percentage estimates. In its previous NEON proposal audit, DCAA found
unsupported bases of estimate for NEON’s proposed contingency costs ($72.6 million); but, in
this accounting system audit, found that NEON claimed an even greater contingency budget
($74.2 million) in the NEON award. 3 As a result of inadequate support for the contingency
estimate, NSF lacks a sound basis to determine how much contingency should be included in
award budgets, which could lead to significant overfunding.

Additionally, in its accounting system audit, DCAA found no requirement in the NEON grant
terms for NEON to track the actual use of contingency expenditures. DCAA explained that 2
CFR 215 requires awardees to be able to compare outlays with budget amounts for each award,
but noted that this regulation is not specific to contingency expenditures or the tracking of those
expenditures. However, as a result of NEON’s not tracking the actual use of contingency
expenditures in its accounting records, NSF has no visibility over how contingency funds are
actually spent. Further, NEON could not provide a comparison of the contingency expended
either for a particular account (because contingency expenditures are not distinguishable from
non-contingency expenditures in NEON’s accounting records) or at the Work Breakdown
Structure (WBS) level, which was the level at which NEON estimated its proposed contingency
costs. In any case, a meaningful comparison of contingency expenditures with estimated
contingencies by WBS is not possible because NEON’s accounting practices are not consistent
with its estimating practices for contingencies.

According to NSF’s Large Facility Manual, the total of the base project cost estimate and
contingency estimate will be the basis for an NSF budget request to Congress. Regarding
NEON’s estimating practices, DCAA noted that contingency is estimated by NEON at the WBS
level, such that, “NEON estimates specific WBS costs with two components: 1) discrete cost
elements for elements of cost, and 2) an additional “contingency” amount…” However,
contingency is not allocated to (or kept within) the WBS elements on which it was estimated, but
is pooled and held in reserve (for use on the project as the need arises). So, contingency
proposed, based on a particular WBS, may ultimately be used to satisfy a requirement under a
different WBS. Further, “NSF guidebooks, cooperative agreement, and regulations do not
require separate accounting for a contingency…Once NEON incurs an expense it pays for with
“contingency funds,” the cost on NEON’s books and records is not (recorded as) a
“contingency” as described in OMB non-profit cost principles, but a specific cost element to a
specific WBS…” Generally, once expenditure is made, even if from contingency funds, the
expense is recorded in NEON’s accounting records as an expenditure of a specific cost element
within a WBS and is no longer identifiable as an expense paid using contingency funds.



3
    NSF Award No. EF-1029808, Cooperative Support Agreement for MREFC of the NEON




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                                                        NSF OIG Audit Report No. OIG-15-6-001


NEON maintains a Contingency Log that provides a list of approved budgeted amounts of
contingencies that are to be spent on the items identified, but the log does not identify actual
expenditures made from contingency funds. NSF cooperative support agreements require NEON
to report on its use of contingency throughout the performance of the project. NEON has
documented Contingency Management and Risk Management Plans, which include documenting
changes approved by the Configuration Control Board and notifying NSF via the Contingency
Control Log. DCAA verified that NEON received approval for contingency requests greater
than the NSF-specified threshold of $150,000.

Given the present lack of controls, there is virtually no accountability over the contingency
funds, either at the expenditure phase or at the estimating phase. NSF does not have sufficient
safeguards over the significant and unsupported contingency costs included in NEON’s award
budget.

DCAA recommended that NSF be required to strengthen its Grant Policy and guidance to
awardees with respect to contingencies on construction projects with regard to estimating,
monitoring, and accounting for contingency expenditures. Specifically, DCAA recommended
that NSF require an awardee to (i) separately track, in more detail than what the awardees are
currently doing, the use of the proposed contingency costs in the budget control log as a
condition of the award (such that the awardee identifies the actual expenditure in the log
compared with the estimated contingency by WBS), and (ii) provide fully supported bases of
estimate for contingencies. The objective of the increased tracking is to provide NSF with better
oversight of how the contingency is used and if the costs incurred are reasonable.

Additionally, DCAA reported a scope limitation regarding contingency expenditures in its
accounting system audit report (under separate transmittal, as stated at the beginning of this
memo). This was because DCAA was unable to determine how much of NEON’s $74.2 million
in total budgeted contingency funds that NEON had used from August 2011 to March 2013
(approximately $4.5 million according to NEON’s Contingency Log) may have been used for
unapproved scope changes. (According to NEON, approximately $12.4 million of contingencies
had been spent through June 2014.) DCAA further stated that, had it completed its planned
procedures (i.e., received a technical evaluation), it may have identified additional
noncompliances.

During the audit, the auditor found possible indications of NEON’s use of contingency funds for
out-of-scope changes, for which NEON did not provide evidence of NSF prior written approval.
2 CFR 215.25(h) requires prior written approval from the Federal awarding agency whenever
changes in scope or objective occur. Thus, we believe there is a need for NSF program officials
with the appropriate technical expertise to examine NEON’s use of contingency funds (i.e., all
items in NEON’s Contingency Log) to determine if each use of those funds was for in-scope or
out-of-scope changes in the project or program. Any instance of out-of-scope use of contingency
funds would be cause for NSF to address inappropriate use of the funds and strengthen its
monitoring and management controls to prevent any further unauthorized use of federal funds.




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                                                        NSF OIG Audit Report No. OIG-15-6-001


Management Fees

During its post-award accounting system audit, DCAA found that Award No. EF-1029808,
Amendment 20, established a not-to-exceed ceiling of $              for management fee for the
life of the NEON cooperative support agreement. DCAA concluded there is a need for NSF to
improve accountability over management fees by monitoring its awardees’ use of the fees.
Monitoring of the types of costs being incurred as a fee is not required by the NEON
cooperative agreement. DCAA reviewed NEON’s use of management fee from 9/20/12 to mid-
April 2013 and found that NEON billed NSF for such normally unallowable costs as $25,000 for
a Christmas party, $11,000 for coffee services for employees, $3,000 for Board of Director
dinners (which included alcohol), $3,000 for t-shirts and other apparel for Contractor employees,
$83,000 for “business development,” and $112,000 for lobbying. OMB Circular A-122
(Attachment B, sections 3, 14, and 25) contains provisions that make costs for entertainment,
lobbying, and alcohol unallowable.

DCAA found that NEON and NSF negotiated a management fee in the cooperative agreements
that NEON uses to pay unallowable/non-reimbursable costs incurred by NEON. In April 2013,
NEON confirmed in an email to DCAA that it was drawing down or billing the fee to NSF on an
incurred cost basis, in the context of reimbursement for incurred unallowable costs, the same as
any (allowable) cost. DCAA reported that the NSF Proposal Award Policies and Procedures
Guide and the NSF Grant Policy Manual address fee in general terms, making it clear that fee is
permissible if approved by the grants/agreements officer, which it was. DCAA could find no
regulation that prohibits the payment of a management fee under a cooperative agreement to a
non-profit entity.

The cooperative agreements awarded to NEON by NSF show the initial management fees were
established at amounts needed to cover expenses that were not reimbursable as costs under the
cooperative agreements but were incurred in the operation of the non-profit entity. According to
DCAA, subsequent awards were made without consideration of the need to reimburse specific
unallowable costs. For example, EF-1247476 of the cooperative agreement established a Not-To-
Exceed amount of $              for management fee for the life of the cooperative agreement
(which at the time of award had several years left). The management fee established for EF-
127476 is       , which is at the low end of NEON’s stated policy of assessing fees of
on NSF projects. However, DCAA was unable to find any NSF Grant Policy determining when
a fee should be awarded or limits on how it is to be used by a non-profit awardee.

DCAA also informed us that it found no other specific NSF authority for the practice of
reimbursing unallowable costs as a management fee. However, NSF has noted in the past this
practice is consistent with the Foundation’s general authority set forth at 42 USC 1870(c).

DCAA recommended that OIG consider requiring NSF to strengthen the NSF Grant Policy to
specify requirements for determining and monitoring the award of management fee. DCAA also
recommended that OIG benchmark with other federal agencies to determine their use of
management fee and how other agencies allow the use of that fee.




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                                                        NSF OIG Audit Report No. OIG-15-6-001


DCAA did not examine NSF’s process to negotiate and award management fees. We are in the
process of having audits performed of the negotiation and use of management fees at selected
non-profit organizations to which NSF has granted management fees. Based on the results of
these audits, we will make recommendations to NSF.

NSF Policy on Reporting Fraud, Waste and Abuse

DCAA also concluded that there is a need for NSF to improve accountability over its policy on
reporting fraud, waste, and abuse. DCAA noted that the NSF Grant Policy Manual does not
require awardees to provide a mechanism for its employees to report suspected fraud, waste,
abuse, and noncompliances directly to the NSF-OIG. Thus, DCAA recommended that NSF be
required to strengthen the NSF Grant Policy to specify requirements for reporting irregularities
or potential irregularities by awardees and awardee employees. The policy could be similar to
the requirements in FAR 52.203-13, which requires an internal reporting mechanism such as a
hotline, which allows for anonymity, or confidentiality, by which employees may report
irregularities.

Recommendations

We recommend that NSF take appropriate action to strengthen its policies and procedures and
guidance to awardees with respect to contingency costs, management fees, and reporting fraud,
waste and abuse, and modify its cooperative agreements and grants accordingly. The objective is
to improve supporting documentation and accountability over costs estimated, incurred and
billed to NSF under NSF-funded projects, including the NEON project. Such actions would
include adopting DCAA’s recommendations and the recommendations listed below.
Specifically, NSF should:

1. strengthen its Grant Policy and guidance to awardees with respect to contingencies on
   construction projects with regard to estimating, monitoring, and accounting for contingency
   expenditures. Specifically, NSF should require awardees to (i) separately track, in more
   detail than what awardees are currently doing, the use of the proposed contingency costs in
   the budget control log as a condition of the award (such that the awardee identifies the
   actual expenditure in the log compared with the estimated contingency by WBS), and (ii)
   provide fully supported bases of estimate for proposed contingencies before including them
   in awards, or internally hold contingency funds until a bona fide need materializes and
   adequate supporting documentation becomes available;
2. work with NEON and other applicable awardees with contingencies in their awards to
   determine if any of their use of contingency funds represent out-of- scope changes for which
   NSF’s prior written approval was not obtained and, if out-of-scope changes are found, take
   appropriate financial action with the noncompliant awardee(s); and strengthen NSF’s
   monitoring and management controls over awarded contingency funds by establishing a
   process to determine if scope is increased at the WBS level to ensure out-of-scope changes
   do not occur; and



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                                                        NSF OIG Audit Report No. OIG-15-6-001


3. strengthen the NSF Grant Policy to specify requirements for reporting irregularities or
   potential irregularities by awardees and awardee employees.


DCAA is responsible for the attached letter, and the conclusions and recommendations expressed
in that letter.

This memo is related to the work on NEON’s accounting system done under OIG Report No. 15-
1-001, and brings to NSF’s attention issues identified during that work that warrant corrective
action. In accordance with OMB Circular A-50, NSF and OIG should agree on a corrective
action plan for resolution of all findings. Please provide us your proposed corrective plan within
60 calendar days.

We thank you and your staff for the assistance extended to us during the audit. If you have any
questions about this report, please contact Jannifer Jenkins at (703) 292-4996 or David Willems
at (703) 292-4979.


Attachments:

DCAA Letter, Observations that Warrant Attention of the NSF-OIG, dated October 23, 2014




cc:    Martha Rubenstein, BFA
       Mary Santonastasso, DIAS
       Matthew Hawkins, LFO
       Fae Korsmo, OD
       Michael Van Woert, NSB
       Ruth David, NSB




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                                   DENVER BRANCH OFFICE
                                      CENTRAL REGION
                              DEFENSE CONTRACT AUDIT AGENCY
                                  DEPARTMENT OF DEFENSE
                                     10375 PARK MEADOWS DRIVE, SUITE 560
                                            LITTLETON, CO 80124-6791

IN REPLY REFER TO


   3121-2013117741001                                                            October 23, 2014
   National Science Foundation
   Office of the Inspector General
   4201 Wilson Boulevard
   Arlington, VA 22230

   SUBJECT:         Observations that Warrant Attention of the NSF-OIG

   Dear Mr. Willems:

          This letter replaces a previous letter issued with this subject on October 6, 2014. The
   only change from the previous letter is a clarification made to the last sentence of the first
   paragraph under the Contingency Expenditures section below.

           DCAA's mission is to perform all necessary contract audits for the Department of
   Defense and provide accounting and financial advisory services regarding contracts and
   subcontracts to all DoD Components responsible for procurement and contract administration.
   These services are provided in connection with negotiation, administration, and settlement of
   contracts and subcontracts to ensure taxpayer dollars are spent on fair and reasonable contract
   prices. DCAA shall provide contract audit services to other Federal agencies, as appropriate and
   when requested.

           Your request for audit of the National Ecological Observatory Network, Inc.'s (NEON)
   accounting system falls within our audit purview. We performed the accounting system audit
   and reported the results in Audit Report Number 03121-2014J11090001, dated October 3, 2014
   (Enclosure 1). As part of your request for an accounting system audit, you also asked our office
   to provide information on whether NEON's accounting system is designed to adequately track
   contingency expenditures in accordance with 2 CFR 215 (OMB Circular A-110). While we
   found no requirement in 2 CFR 215 for tracking contingency expenditures (discussed further
   below), we note that EF-1138160 Award Speeifie Programmatie Terms and Conditions No.6,
   required NEON to notify the NSF of all proposed uses of contingency via a change control
   database. NEON's contingency control log provides that notification to NSF.

          Nevertheless, we are providing information related to your concerns with contingencies
   and other matters that came to our attention. We believe the information presented below will
   help NSF improve its management controls in those areas.
3121-2013117741001                                                             October 23, 2014
SUBJECT: Observations that Warrant Attention of the NSF-OIG

Contingency Expenditures

       As mentioned above, based on what we noted during the accounting system audit, there is
no requirement for NEON to track the actual use of contingency in its awards. 2 CFR 215 only
requires comparison of outlays with budget amounts for each award. It is not specific to
contingency expenditures or the tracking of those expenditures. NEON maintains a Contingency
Log in which it captures approved budget for contingency expenditures to be made from
"contingency funds."

         NSF has a "Draft Definition and Use of Contingency Resources in NSF Facility
Construction" document that instructs awardees to develop estimates of contingency costs
representing anticipated cost growth for major construction projects such as the NEON
observatories. The contingency estimate represents the portion of the project's construction
budget to account for unknowns relating to the requirements and the uncertainty that are within
the scope of the project (Definition and Use of Contingency Resources in NSF Facility
Construction- May 6, 2004 Draft, p. 3). NSF's Risk Management Guide for Large Facilities
(2012) defines contingency as "the amount added to an estimate to allow for items, conditions, or
events for which the state, occurrence, or effect is uncertain and that experience shows will likely
result, in aggregate, in additional costs" (p. 16). Contingency includes "items such as planning
and estimating errors and omissions, minor labor or material price fluctuations, design
developments and changes within the project scope, labor productivity losses due to congestion
or contractor interferences, and variations in market and environmental conditions" (Risk
Management Guide for Large Facilities (NSF Publication No. NSF 12-048), p. 6). The total of
the base project cost estimate and contingency estimate will be the basis for a NSF budget
request to Congress (Large Facilities Manual (NSF Publication No. NSF 13-38), p. 8 and 20).

        NSF guidebooks, cooperative agreement, and regulations do not require separate
accounting for a contingency as used in the nature and context of contingency by the NSF.
NEON estimates specific WBS costs with two components; (i) discrete cost estimates for
elements of cost, and (ii) an additional "contingency" amount for anticipated cost growth due to
various factors. Once NEON incurs an expense it pays for with "contingency funds," the cost on
NEON's books and records is not a "contingency" as described in the OMB non-profit cost
principles, but a specific cost element to a specific WBS, as it would for any project (i.e., labor).

        However, NSF cooperative support agreements require NEON report on its use of
contingency throughout the performance of the project. For instance, EF-1029808 Award
Specific Programmatic Terms and Conditions requires NEON to provide monthly technical
reports that includes reporting on contingency expenditures for the reporting period, update of
graphical presentation of contingency usage, as a percentage of cost to go, and forecasts on
potential, future contingency liens for the project. In addition, it requires NEON to report on its
risk management activities for the reporting period. During our review we noted NEON has
documented Contingency Management and Risk Management Plans, which include documenting
changes approved by the configuration control board and notifying of NSF via the Contingency
Control Log.



                                                  2
3121-2013117741001                                                            October 23, 2014
SUBJECT: Observations that Warrant Attention of the NSF-OIG

         We recommend you consider requiring NSF to strengthen its Grant Policy and guidance
to awardees with respect to contingencies on construction projects with regard to estimating,
monitoring, and accounting for contingency expenditures. Specifically, have NSF require an
awardee to (i) separately track in more detail, than what the contractors are currently doing, the
use of the proposed contingency costs in the budget control log as a condition of the award, and
(ii) provide fully supported bases of estimate for contingencies. However, when considering the
broad definition of contingency as defined by NSF, the tracking will not be an exact
representation of the contingency, but will provide NSF with better oversight of how the
contingency is used.

Management Fees

        Based on what we observed during the accounting system audit, NEON and NSF
negotiate a "management fee" in the cooperative agreements that NEON uses to pay
unallowable/non-reimbursable costs incurred by NEON. The NSF Proposal Award Policies and
Procedures Guide and the NSF Grant Policy Manual address fee in general terms, making it clear
that fee is permissible if approved by the grants/agreements officer, which it was. We can find
no regulation that prohibits the payment of a management fee under a cooperative agreement to a
non-profit entity.

       The cooperative agreements awarded to NEON by NSF shows the initial management
fees were established at amounts needed to cover expenses that were not reimbursable as costs
under the cooperative agreements but were incurred in the operation of the non-profit entity.
Subsequent awards were made without consideration of the need to reimburse specific
unallowable costs. For .xamfe, EF-1247476 of the cooperative agreement established a Not-
To-Exceed amount of$              for management fee for the life of the cooperative agreement
(which at the time of award had several years left). The management fee established for EF-
127476 is.%, which is at the low end ofNEON's stated policy of assessing fees o f -
on NSF projects.

        However, we were unable to find any NSF Grant Policy determining when a fee should
be awarded or how a negotiated fee is used by a non-profit entity. We recommend that you
consider requiring the NSF to strengthen the NSF Grant Policy to specify requirements for
determining and monitoring the award of fee. We also recommend you benchmark with other
federal agencies to determine their use of management fee and how other agencies allow the use


NSF Policy on Reporting Fraud, Waste and Abuse

        Based on what we noted during the accounting audit, the NSF Grant Policy Manual does
not require awardees to provide a mechanism for its employees to report suspected fraud, waste,
abuse, and noncompliances directly to the NSF-OIG. We recommend that you consider
requiring the NSF to strengthen the NSF Grant Policy to specify requirements for reporting
irregularities or potential irregularities by awardees and awardee employees. The policy could
be similar to the requirements in FAR 52.203-13, which require an internal reporting mechanism



                                                 3
3121-2013J17741001                                                         October 23, 2014
SUBJECT: Observations that Warrant Attention of the NSF-OIG

such as a hotline, which allows for anonymity, or confidentiality, by which employees may
report irregularities.




                                               Sincerely,




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