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Posted on Monday, September 10, 2012

Whistleblowing Sounds Again

The Department of Justice recently joined a whistleblower’s lawsuit alleging that The Gallup Organization (Gallup) violated the Truth in Negotiations Act (“TINA”), 10 U.S.C. §2306a, in United States ex rel. Lindley v. Gallup, DCDC No. 1:09cv01985.

TINA provides that (in most cases), before the government awards a sole source contract, the contractor must submit and certify “cost and pricing data” on which the contractor bases its estimated cost of providing the goods of services, including labor hours required to perform the work.  If a contractor submits false cost or pricing data the contractor commits misconduct commonly referred to as “defective pricing.”  If a contractor knowingly engages in defective pricing, then the contractor violates the False Claims Act.

According to the allegations, Gallup compensated its employees based, in part, on the gross margin generated by projects for which the employees were responsible.  Under Gallup’s pay-for-performance system, employees received incentive compensation based on the projects gross margin – i.e., the difference between total costs and revenue.  Gallup had many years of historical data showing the cost of performing contracts.  The complaint alleges that Gallup employees submitted false cost and pricing data to the government, inflating the supposed cost of performing contracts in order to artificially increase the price of the contracts.  The employees kept a separate internal set of books showing the actual lower costs which the Gallup used to calculate its gross margin and the amount of the employees’ incentive pay.

The complaint also alleges other misdeeds by Gallup, including shifting costs from fixed-price to cost-plus contracts, improperly upgrading labor categories, and conflicts of interest.  But the flagship allegation is the alleged violation of TINA.  The fact that Department of Justice has joined the lawsuit shows that DoJ believes that the whistleblower’s claims have substantial merit.

Gallup’s compensation system is an example of how a compensation system that was intended to incentivize employees to increase the company’s gross margin by reducing costs can have the opposite effect of encouraging employees to increase profit margins by submitting false cost and pricing data, thereby fraudulently inflating the price of sole source contracts.  As this case illustrates, it is important for contractors to carefully assess their compensation systems to assure they do not encourage fraud.

The author, John W. Polk, is an attorney with Berenzweig Leonard LLP located in the Washington, D.C. region.  He can be reached at jpolk@berenzweiglaw.com.