DATE: May 26, 1998

SUBJECT: Nebraska Health and Human Services System

Docket No. A-97-72
Decision No. 1660

DECISION

The Nebraska Health and Human Services System (Nebraska) appealed the decision of the HHS Regional Director for Region X upholding an earlier determination of the HHS Division of Cost Allocation (DCA). DCA disallowed $259,081.09 in federal funding for contract costs of $535,193 in Nebraska's June 1996 fiscal quarter. See Nebraska Exhibit (Ex.) 11 to its Response to Order to Develop the Record (Nebraska Response). The costs at issue reflected contract fees to a private consulting firm for consulting services. DCA concluded that the contract fees were unallowable because they were based on a contingency fee arrangement. The DCA disallowance letter asked Nebraska to make a negative adjustment in Cost Pool F of the September 30, 1996 cost allocation plan (CAP) application for the costs charged in June 1996.

As discussed below, we conclude that the consultant contract costs in question were not allowable because they were not "reasonable" costs within the meaning of the applicable cost principles. Accordingly, we uphold the disallowance.

I. Factual Background

Effective August 1, 1994, Nebraska entered into a contract with the private consulting firm "MAXIMUS." The contract stated, in relevant part:

Whereas [Nebraska] is desirous of contracting for the generation of additional Federal revenues on behalf of [Nebraska's] health [and] human services programs; and ... MAXIMUS has successfully provided these same services to a number of other states ...

Now, therefore, the parties agree as follows:

II. Scope of Services by Contractor.

The Contractor agrees that for valuable consideration provided by [Nebraska], to perform the following tasks:

6. Prepare one or more "baseline" letters .... Each baseline letter will include:

an executive summary of the program area within which work is to be performed, quantification of the current funding of that program area by fund source, and a clear and precise description of "increased revenues." The description will identify the method used to determine the amount of non-general fund revenues that would have been received by [Nebraska] without the Contractor's involvement, as well as the basis upon which the Contractor's fee will be established.

7. For each approved baseline, prepare one or more management letters describing the work to be performed including responsible party, to generate increased revenues on behalf of [Nebraska].

10. Assist [Nebraska] in all negotiations with the State or Federal agencies to ensure that the increased revenues identified by the Contractor are received by [Nebraska]. Nebraska reply, Ex. 1, at 1, 2, and 3.

As consideration for the services provided by MAXIMUS, Nebraska agreed to pay MAXIMUS under a contingency fee arrangement. MAXIMUS would receive twelve and one-half percent (12 1/2%) "of the total net increase FFP revenues earned" by Nebraska over a two-year period defined according to the contract. Id. at 4. Nebraska maintained that the purpose of the MAXIMUS contract with this contingency fee arrangement was to assist Nebraska in ensuring that it was "claiming all proper available [FFP]" for the various federal programs administered by Nebraska, including programs under titles IV-A, IV-B, IV-D, IV-F, XIX and XX of the Social Security Act. Id.; Nebraska brief (Br.) at 1.

Although the contract became effective earlier, Nebraska claimed the costs only for the June 1996 fiscal quarter. The costs were claimed in the quarterly CAP in Cost Pool F, which is allocated to all activities based on full-time equivalent positions. However, Nebraska did not allege that its approved CAP provided for including these specific costs in any cost pool. By letter dated September 19, 1996, DCA disallowed $535,193 in total costs claimed by Nebraska for the MAXIMUS contract which were charged to all federal programs operated by Nebraska's Social Services Department. The determination was affirmed on reconsideration by the Regional Director.

Although the Regional Director concluded that Nebraska had correctly argued that the 1981 version of Office of Management and Budget Circular A-87 (OMB A-87) was the version applicable to the contract costs at issue, rather than the 1995 version cited by DCA in its disallowance letter, the Regional Director nevertheless determined that the costs were not allowable under either version of OMB A-87. The Regional Director reasoned that the claimed costs were unallowable based on the provision specifying that costs for professional services are allowable with approval of the grantor agency, OMB A-87, Attachment B, C.7., and the provision making contributions to contingency reserves unallowable, OMB A-87, Attachment B., D.2. Nebraska appeal file, Ex. 7 at 1.

In support of the Regional Director's determination before the Board, DCA argued that the cost of the services in question was not allowable under the "Basic guidelines" for allowability of costs in the cost principles. The "Basic guidelines" require that in order to be allowable, costs must meet the following general criteria: "Be necessary and reasonable for proper and efficient administration of the grant programs." OMB A-87, Att. A, C.1.a. DCA argued that the costs were not "necessary and reasonable" because the "purpose of [the] contract was to increase the amount of Federal funding to the State, not to improve the administration of the programs themselves." DCA Br. at 4.

After the parties had submitted their initial briefing in this appeal, the Board in an Order to Develop the Record specifically asked the parties to address the question of whether a cost for professional services could be "reasonable" in amount under the "reasonable and necessary rule" if the costs were based solely on a contingency fee arrangement, and thus did not reflect the actual time and effort expended in performing the services. In its response to the order, DCA argued that a contingency fee arrangement did not provide a reliable basis for establishing the reasonableness of a claimed cost. DCA Response to the Board's Order (DCA Response), p. 1. Although Nebraska did not dispute the applicability of the "reasonableness" requirement in assessing the size of the fee, it argued that the reasonableness of the fee must be reviewed in terms of the "prevailing circumstances." Nebraska Response at 3. Nebraska then provided extensive arguments as to why the fee in question would be reasonable under the circumstances here.

In addition to giving the parties the opportunity to brief the reasonableness issue in response to specific questions in the Board's order, the Board convened a telephonic conference on March 25, 1998, to enable the parties to comment orally on each other's written submissions. The Board retained the tape of the conference for the record in this appeal.

II. Legal Background

Federal regulations require that a state claim funding for costs of public assistance programs in accordance with the state's approved CAP. 45 C.F.R. . 95.517 (1995). The CAP must conform to accounting principles and standards prescribed in OMB A-87 and other pertinent HHS regulations and instructions. 45 C.F.R. . 95.507(a)(2). Federal regulations also specify that the allowability of costs incurred by state governments under federal grants shall be governed by OMB A-87. 45 C.F.R. .. 74.27(a) and 92.22(b).

OMB A-87, Attachment A (1981) provided, in pertinent part:

C. Basic guidelines.

1. Factors affecting allowability of costs. To be allowable under a grant program, costs must meet the following general criteria:

a. Be necessary and reasonable for proper and efficient administration of the grant programs, be allocable thereto under these principles ....(Emphasis supplied.) OMB A-87, Attachment B, provided, in pertinent part:

C. Costs Allowable With Approval of Grantor Agency

7. Professional services. Costs of professional services rendered by individuals or organizations not a part of the grantee department are allowable subject to such prior authorization as may be required by the Federal grantor agency.

Finally, the regulation at 45 C.F.R. . 74.45 requires that cost or price analysis must be made and documented in procurement files in connection with every procurement action. See also 45 C.F.R. . 74.46.

III. Analysis

The primary issue raised by this disallowance is whether the cost of the consultant contract at issue is a "reasonable and necessary" cost within the meaning of the "basic guidelines" of the cost principles.

We conclude that the cost is not "reasonable" because the contingency fee arrangement fails to guarantee that the fee will bear an appropriate relationship to the amount of time and effort required to perform the professional service. In the context of the federal programs at issue, a consultant could expend a very small amount of time and effort and still obtain millions of dollars in fees under a contingency fee contract. Indeed, in the instant case, the total contract fee for less than a two-year period exceeded $2.5 million, and the consultant was not required under the contract to provide any substantiation of the time or effort involved.

Nebraska argued, nevertheless, that contingency fee contracts should not automatically be viewed as unreasonable and that the reasonableness of each contract should be considered in the context of the "prevailing circumstances." Nebraska Response, p. 3. Nebraska argued that the contractor devoted very substantial numbers of staff who performed "literally hundreds if not thousands of hours of work in the performance of the various reviews and analyses" undertaken under the terms of the contract. Id. Nebraska provided seven exhibits which it asserted were examples of the extensive effort that was undertaken.

None of Nebraska's exhibits, however, documents how much time and effort were expended under this contract. Nebraska apparently is unable to make even a rough estimate of the time expended since the most definite statement in its brief is that the contractor staff performed "hundreds if not thousands of hours of work." Nevertheless, even if we assume, based on this statement, that the contract staff spent 500 hours in fulfilling the terms of the contract, the contractor would have been compensated at the rate of $5,000 per hour, based on total contract fees of over $2.5 million. Even if the contract staff had spent 1,000 hours of time, the hourly rate would still have equalled $2,500. Nebraska provided no evidence to substantiate the reasonableness of such extraordinary hourly fees under the circumstances here.

Moreover, as DCA argued, the use of a contingency fee contract made it impossible for Nebraska to provide the type of cost and price analysis that the regulations require in advance of a state's procurement. The regulations at 45 C.F.R. . 74.45 require the following analysis:

Some form of cost or price analysis shall be made and documented in the procurement files in connection with every procurement action. Price analysis may be accomplished in various ways, including the comparison of price quotations submitted, market prices and similar indicia, together with discounts. Cost analysis is the review and evaluation of each element of cost to determine reasonableness.

Nebraska did not allege here that it had prepared (or indeed that it even was possible to prepare here) the type of cost analysis contemplated by section 74.45. Moreover, neither section 74.45 nor any other section in 45 C.F.R. Part 74 (covering the uniform administrative requirements for grant administration) contemplates that a state may use a contingency fee arrangement in procuring professional services in the administration of a grant.

Nebraska did not claim contingency fee costs for any earlier contract period under any federal program and Nebraska did not here argue that it had any affirmative basis in Department regulations or policies to think that such fees would be allowable for the particular quarter at issue.

DCA argued that a contingency fee arrangement is neither a customary nor usual fee arrangement for claiming grant costs in government and that it knew of no contingency fee contract cost that had ever been an allowable claim to any federal program anywhere. It added as follows:

Several other states have contracted with [MAXIMUS] using a similar contingency fee arrangement, but no other state has charged the costs of the contingency fee contract to any Federal program. Most, if not all state grantees are aware that contingency fee contract costs are not an allowable charge to Federal programs. DCA believes Nebraska was aware this fee could not be charged to Federal programs. DCA Response, p. 2.

Furthermore, while it may be true, as Nebraska argued, that the contractor MAXIMUS brought a particular expertise to the task that was not available through Nebraska's full-time staff, that factor alone would not establish that the contract cost under the contingency fee arrangement was reasonable. Nebraska did not argue that it could not contract to receive the necessary specialized expertise through a different fee arrangement. Moreover, contrary to what Nebraska argued, the fact that the fee in question may have approximated the total salaries of a staff of forty-five of Nebraska's own employees for an entire year would not substantiate the reasonableness of the costs in question when we have no idea of the amount of time and effort expended by the MAXIMUS staff.

Thus, contrary to what Nebraska argued, Nebraska has failed to document the reasonableness of the fee under the "prevailing circumstances" of this particular contract. This Board has repeatedly held (citing, for example, 45 C.F.R. .. 74.21(b) and 92.20(b)) that the burden rests with the grantee to document all aspects of the allowability of its claimed costs. See, e.g., Puerto Rico Treasury Department, DAB No. 1593 (1996); New York State Dept. of Social Services, DAB No. 1076, at 21-24 (1989). The "reasonableness" of the contract fee here is a basic consideration concerning the allowability of these costs under the cost principles.

Finally, although DCA originally relied on a later version of OMB A-87 with a more explicit prohibition of these costs, we conclude that DCA (and this Board) may properly rely on the basic "reasonableness" requirement in effect during the applicable period. The applicable version of OMB A-87 provides that the standards in Attachment B for determining allowability of selected items of cost (such as professional fees) are subject to the general policies and principles in Attachment A (such as the reasonableness principle). OMB A-87, Att. B., A.2. Moreover, Nebraska has had adequate opportunity during the Board's process to respond to the issue of the applicability of the reasonableness requirement. The Board afforded Nebraska opportunity both to submit written briefing and to make an oral presentation on this issue. The Board has long held that a grantee is not prejudiced by late notice of the basis of the disallowance as long as there is opportunity during the Board's process for the grantee to respond to what the Board determines to be the applicable requirements in support of the disallowance. See, e.g., Illinois Dept. of Children and Family Services, DAB No. 1530 (1995); Kansas Dept. of Social and Rehabilitation Services, DAB No. 782 (1986). The Board is bound to apply all applicable regulations. 45 C.F.R. . 16.14.

Accordingly, on the basis of the foregoing analysis, we conclude that the contract cost at issue was unallowable because it was not a "reasonable" cost within the applicable cost principles. Moreover, Nebraska has provided no documentation to support what would be a reasonable cost for the services at issue. In view of these conclusions, we do not need to consider whether other cost principle provisions relied upon by DCA in its briefing before the Board are also applicable.

Conclusion

Based on the foregoing analysis, we conclude that DCA properly disallowed the costs at issue here.

Judith A. Ballard

M. Terry Johnson

Donald F. Garrett
Presiding Board Member