Department of Health and Human Services DEPARTMENTAL APPEALS BOARD Appellate Division |
|
IN THE CASE OF | |
|
DATE: October 25, 2000 |
Docket No.A-97-160 Decision No. 1751 |
|
DECISION | |
DECISION Orange County, California (Orange County) appealed a determination by the Regional Director, Region IX, of the Department of Health and Human Services (DHHS or Agency), affirming a Division of Cost Allocation (DCA) disallowance of $7,179,387 in professional consultant costs charged to DHHS grants pursuant to Orange County's 1996-97 proposed cost allocation plan (CAP). Orange County incurred the consultant services to sustain its operations and to assist it through federal bankruptcy proceedings. The Agency found that costs arising from Orange County's bankruptcy proceedings were not allocable to Orange County's federal grants and were not allowable under the applicable federal cost principles. For the reasons discussed below, we find that federal cost principles bar the use of federal funds for the costs associated with Orange County's bankruptcy. Specifically, we find that the consultant costs incurred because of Orange County's bankruptcy were not allocable to any federal grant program, were not reasonable costs to federal grants, and were unallowable general government expenses and investment management costs. Accordingly, we sustain the disallowance in its entirety, subject to a reduction, as discussed below, for certain costs associated with the accounting firm Arthur Anderson, which the Agency has identified as allowable or potentially allowable. Background Orange County, under the direction of its Treasurer, operated an investment pool, with the moneys from the pool invested in a variety of securities. While the investment pool generated high rates of return in the early 1990's, the pool suffered substantial losses in market value in 1994 when interest rates increased. See DCA Ex. 1, at 18. As a result of the downward turn in the investment activities undertaken by Orange County's Treasurer, Orange County ultimately was forced to file for protection under Chapter 9 of the United States Bankruptcy Code on December 6, 1994. The Bankruptcy Court's Second Amended Disclosure Statement contained the following description of the Treasurer's investment activity:
DCA Ex. 1, at 55. Orange County's Treasurer subsequently
pled guilty to six felony counts. Id. With the liquidation of the pool's portfolio, Orange County
incurred investment losses of approximately $1.6 billion. In the aftermath of its filing for bankruptcy, Orange County initiated a recovery plan to address the budget deficit that resulted from the investment losses and to recover from the bankruptcy. As part of this recovery plan, Orange County incurred the professional consultant costs that are the subject of this appeal. These consultant costs included payments to accounting firms, investment banking and financial advisory services, bond counsels, and bankruptcy litigation firms. Orange County broke these costs down in what was designated in its CAP as "Agency 018 Cost Grouping---FY 1994-95 CWCAP Costs." Orange County Ex. O at last page. This schedule listed 14 firms that provided various services to Orange County in the aftermath of its bankruptcy. Orange County further divided these professional consultant costs between those that were ordinary and necessary during a period of recovery ($3,845,195 under a column entitled "Recovery/Restructuring Costs") and those costs that would be considered ordinary and necessary during non-recovery circumstances ($3,334,192 under a column entitled "Normally Claimable Costs"). Orange County Ex. O at last page. Orange County claimed both types of costs, for a total of $7,179,387 in professional consultant expenses, pursuant to its proposed 1996-97 county-wide CAP. Orange County advised the California State Controller of its intent to include these costs in its 1996-97 CAP as being both reasonable and necessary for the continued operation of its federal programs. Orange County Ex. A. The California State Controller made two separate opinions that the consultant costs were "investment expenses" and therefore unallowable for inclusion and allocation in Orange County's CAP. Orange County Exs. B and D. Orange County appealed the State Controller's decision to DCA. Orange County Ex. E. DCA upheld the State Controller's decision, finding that Orange County's bankruptcy resulted from the Treasurer's investment "in highly speculative and interest rate sensitive instruments." Orange County Ex. K, DCA Decision at second page. DCA further found that, while the bankruptcy expenditures may have been necessary for Orange County to continue its operations, the costs were not necessary for the efficient administration of federal grants:
Id. at third page. Orange County appealed DCA's decision to the DHHS Regional Director. Orange County Ex. L. The Regional Director upheld DCA's determination disallowing all bankruptcy-related consultant costs. DCA had found that Orange County's bankruptcy was brought about by the "speculative and illegal investment activities" of Orange County's Treasurer, and that costs associated with bankruptcy activities were not allocable to Orange County's federal grants and were unallowable for reimbursement under the CAP. The Regional Director found that the bankruptcy-related consultant costs were not reimbursable under the cost principles set forth in Office of Management and Budget Circular A-87 (A-87). The allowability of costs incurred by local governments such as Orange County is determined in accordance with the provisions of A-87. 45 C.F.R. � 74.27(a). In affirming DCA's determination, the Regional Director made the following points in relation to the claimed consultant costs and various provisions of A-87:
Regional Director's April 1, 1997 letter at 2 - 3. Discussion The Agency relied on basic guidelines as well as specific
rules on allowable costs put forth in A-87, which it asserted "blanket"
and "re-blanket" these costs in support of its disallowance. Oral Argument
Transcript at 15. As discussed in detail below, we agree that these guidelines
and rules fully support the Agency's disallowance. 1. The costs are not allowable because they were not
"allocable" to any of Orange County's grant programs. The cost principles provide as a basic consideration in determining the allowability of a cost that the cost be "allocable" to the federal grant. Att. A, � C.1.b. A cost is "allocable" to a particular federal award or cost objective: "if the goods or services involved are chargeable or assignable to such cost objective in accordance with relative benefits received." Att. A, � C.3.b. The Agency argued that the consultant costs at issue here provided no specific benefit to any federal grant program and therefore were not allocable to any program. Costs that provide specific benefit to grant programs are typically costs that are authorized by the authorizing statute as being necessary to fulfill program objectives. Indeed, the guideline on "allocability" implements the basic principle of grant law that federal grant funding is only available to the extent authorized by law and available appropriations. Principles of Federal Appropriations Law, 2d ed., U.S. General Accounting Office, VOL. 11, at 10-20. Orange County argued at some length about the possible benefits to federal grant programs arising from the consultant services, citing such benefits as the continued viability of the Orange County government, its ability to set priorities and provide continuity in the administration of its programs, and its ability to provide restitution to the claims of Orange County investment pool participants and creditors. None of these so-called benefits to federal grant programs, however, are uniquely or specifically assignable benefits to federal programs. Indeed, Orange County failed to cite one example where an authorizing statute for any of the various federal grant programs involved in this appeal provided authority for the costs in question, that is, costs in support of the continued viability of a grantee governmental entity. Moreover, as the Agency argued, federal grant programs are premised on the assumption that there will already be a grantee entity in place to administer the program when the grant is awarded and the funding received. It is not the role of federal grant programs to create or maintain a governmental entity that receives grant funding. Participation in federal grant programs is voluntary on the part of grantees. The federal agency is nowhere obliged to deal with a governmental entity that is unable or unwilling to comply with the minimum prerequisites of the programs involved. Thus, professional consultant costs for maintaining the viability of Orange County and allowing it to continue to operate its federal programs following its extensive investment losses are simply not authorized costs of the grant programs involved, nor are the costs "allocable" to those programs. Indeed, as we discuss below, the rule stating that general government expenses are not allowable costs to federal grants clearly applies to the costs of maintaining the viability of a governmental entity. The Agency, moreover, argued that professional consulting costs of the type at issue here must be claimed as a "direct" cost of a federal grant under A-87 (to the extent they are allocable and allowable), and not as an "indirect" cost as Orange County here structured its claim. As defined by A-87, "direct" costs are costs that can be identified specifically with a final cost objective of a grant. See Att. A, � E.1. Clearly, the costs at issue here have not been "specifical1y" identified by Orange County with a final cost objective of any federal grant, and thus would not be "allocable" to any grant as a "direct" cost. Orange County presumably claimed the costs as indirect costs based on the nature of the common or joint "benefit" that Orange County imputed for these activities. Indirect costs, however, must still provide specific identifiable benefits to federal grant programs. The only difference between a direct and indirect cost is that indirect costs further common or joint purposes and therefore the amount of the specific benefit may not be readily assignable to the cost objective "specifically" benefitted. Att. A, � F.1. In its last brief to the Board in this appeal, Orange County summarized its position by stating that there is no requirement in A-87 that indirect costs specifically benefit federal programs.(1) This argument represents a fundamental misconception
of both the wording and purpose of A-87. The "General" statement on indirect
costs makes it absolutely clear that even though indirect costs may not
be "readily" assignable to cost objectives because they benefit more than
one cost objective, they nevertheless must provide specific benefit to
each of the cost objectives benefitted.(2)
Accordingly, on the basis of the foregoing, we conclude
the costs at issue here are not allowable because they were not allocable
to federal grant programs. 2. The costs at issue are not allowable because they
were general government expenses. The A-87 cost principles provide that the general costs
of government are unallowable. The specific rule is as follows:
Orange County steadfastly justified the costs for the consultants on the ground that the assistance of the consultants effectively allowed the county to maintain its operations "at a level necessary and appropriate to the continued viability of the County." Reply Br. at 8. Orange County also argued that the consultant assistance provided the County with continued control over its programs and allowed it to set priorities in those programs during the financial recovery process. Id. The primary difficulty with Orange County's position is that all of the identified purposes represent general governmental objectives, the primary one being the continued viability of the County as a governmental unit. None of the consultant costs specifically benefitted the federal grant programs. The obvious rationale for the general government expense prohibition in A-87 is that the general costs of government provide too attenuated a benefit to any federal grant program to merit being charged against that program. Obviously if Orange County lacked a police department, there might be such civil unrest within its boundaries that no federal grant program could be operated in Orange County. Nevertheless, the cost principles deem the costs associated with a police department to be an unallowable cost to a federal grant program because the activity is a "general" expense. Moreover, although expenses associated with a bankruptcy
are not specifically identified in the "general government expenses" provision
itself as one of the prohibited expenses, that provision, as its language
suggests, is only intended to give illustrative examples and not a comprehensive
list of every single general government expense. Professional services
costs associated with bankruptcy proceedings are uncommon, extraordinary
expenses for a governmental unit that do not even involve the employees
or officials of the governmental entity itself. For this reason, we do
not find it significant that these costs were not included as an "example"
of a general government expense. Accordingly, we conclude that the consultant services costs at issue here are not an allowable cost to federal grant programs because, among other things, they were a general government expense of Orange County. Indeed, it would appear that the rule on general government expenses overlaps or implements the basic consideration of "allocability" imposed by the cost principles on both direct and indirect costs. We here conclude that from the perspective of either rule, the subject bankruptcy costs are unallowable. 3. The consultant costs are unallowable because they were not reasonable costs to federal grants. The cost principles provide, again as a "basic guideline,"
that costs be "necessary and reasonable for proper and efficient performance
and administration of Federal awards." Att. A, � C.1. The cost principles further provide that in determining
the reasonableness of a given cost, consideration should be given to such
factors as:
We here conclude that the consultant costs at issue arising from Orange County's bankruptcy cannot be viewed as reasonable costs to the federal grants on the basis of any of the factors identified above. First and foremost, Orange County failed to demonstrate
that the consultant costs here are the type of cost that is generally
recognized as "ordinary" for the operation of a governmental unit. Black's
Law Dictionary defines the adjective "ordinary" as: "Occurring in the
regular course of events; normal; usual." (7th Ed., 1999).
Orange County did not cite one other instance where a governmental unit
was forced to incur professional consultant fees in conjunction with a
bankruptcy process resulting from the governmental unit's reckless investment
practices. Even if there have been other similar instances of bankruptcy
in the history of the nation or indeed of California, this type of cost
would hardly rise to the level of being considered an "ordinary" expense.
Expenses arising from a bankruptcy are extraordinary expenses because
the condition of bankruptcy is not a routine or normal condition in business
or in government; it is rather an exceptional condition following a serious
reversal of fortune that causes an entity to be unable to pay its debts
in the ordinary course of its operations. Moreover, these costs cannot
be viewed as "necessary" for federal programs when they arose out of the
county government's reckless and unmonitored investment activities. Clearly,
Orange County's Treasurer and other county officials responsible for the
losses knew or should have known that there were risks associated with
reckless investment practices and that if losses were incurred as a result
of the reckless practices, there might be attendant expenses of the nature
incurred here. Thus, these costs were not "necessary" because they could
have been avoided if Orange County officials had followed prudent investment
practices. Similarly, we conclude that these costs were not "reasonable"
because Orange County officials responsible for the bankruptcy did not
exercise restraint "imposed by sound business practices" and because the
officials had not "acted with prudence considering their responsibilities
to the governmental unit, its employees, the public at large, and the
Federal Government." Orange County conceded that the investments giving
rise to the bankruptcy were "speculative" and "unduly risky." Reply Br.
at 2. It quoted from the bankruptcy judge's decision that characterized
the investments as "unwise," "speculative," and "unduly risky," but not
"ultra vires" on the part of the County Treasurer who was responsible
for making the investments. Id. at 5. In spite of these concessions,
Orange County nevertheless argued before us that the professional consultant
fees at issue here may be viewed as "reasonable" costs because the cause
of the bankruptcy proceedings should have no bearing on the Board's application
of the cost principles and because Orange County's bankruptcy plan was
preferable to other alternatives available to Orange County. According
to Orange County, the only question the Board should ask is whether Orange
County acted reasonably in incurring these particular professional consultant
costs at the time the decision was made to incur the costs. We categorically
reject this line of argument. Consideration of the allowability of the professional
consultant expenses at issue here cannot be separated from the activities
that gave rise to the need for the services. Thus, in evaluating the reasonableness
of the consultant services, we must look not only at Orange County's circumstances
at the specific time it decided to incur the consultant costs, we need
to ask as well whether Orange County was following sound business practices
and acing prudently in embarking on the investment practices that might
predictably lead to the need for these consultant costs. The need for
these services did not arise in a vacuum. As the Agency argued, the consultant
costs were associated with, were directly caused by, and would not have
been incurred but for Orange County's unsound and imprudent investment
practices, and to the extent that Orange County could have avoided those
practices (which it indisputably could have), it could also have avoided
incurring the professional services costs here at issue. These costs therefore
must be viewed in the context of and bear the taint of the imprudent practices
that gave rise to the need for the services. Thus, while Orange County
may have selected the best of several possible remedial courses of action
after it incurred the investment losses, these remedial costs cannot be
viewed as "reasonable" if Orange County could have avoided them altogether
by acting prudently to begin with. We also conclude that it is irrelevant that the primary
responsibility for the unduly risky investments rests with the County
Treasurer, an elected position, and not the county entity that decided
to incur the professional consultant costs during bankruptcy proceedings,
the County Board of Supervisors. Under A-87, a local government includes
a "county" and any "agency" or "instrumentality" of a county. Att. A,
� B.13. Likewise, a "governmental unit" means the entire local government
including any component thereof. Id. Thus, under the cost principles,
Orange County as a whole must assume responsibility for the imprudent
and reckless investment activities that directly gave rise to the need
for the professional consultant services costs at issue here. Accordingly, on the basis of the foregoing, we conclude
that the costs at issue are not allowable because they were neither "ordinary"
nor "necessary" for the operation of the governmental unit or the performance
of the federal award (and thus not "reasonable" for the proper and efficient
performance and administration of federal grant awards.) These consultant
costs were also not "reasonable" because they were the direct result of
unsound, reckless and unmonitored investment practices and the failure
to act with prudence under the circumstances. 4. The costs at issue are unallowable because they
were investment management costs. Attachment A of A-87 states in pertinent part:
We conclude that the consultant costs at issue here are encompassed within the "investment management" cost prohibition because, again, they were directly associated with, caused by and would not have been incurred but for Orange County's imprudent and reckless investment activities. Orange County's investment activities that gave rise to its bankruptcy were specifically designed to enhance Orange County's income and indeed for a number of years preceding 1994 did in fact enhance its income. Orange County effectively conceded that the immediate investment activities are not allowable costs of any federal grant program by not claiming them. Indeed, we are aware of no federal grant program which has as its specific objective the investment of grant funds in order to enhance income from such investments. We here conclude that the consultant costs reasonably must be encompassed within the prohibited investment management costs by virtue of their direct and close relationship to the investment activities that gave rise to Orange County's extensive losses. The prohibition, moreover, is not narrowly drawn and includes the costs of "counsel" and "similar" expenses. (In addition, A-87 provides that where a particular item of cost is not mentioned in Attachment B, the determination of whether the cost is allowable should be based on treatment or standards provided for similar or "related" items of cost.) Where a governmental entity undertakes a course of imprudent and unduly reckless investment activities, that entity must reasonably contemplate that it may need to incur the type of related professional consultant expenses that Orange County was forced to incur in this instance. We therefore conclude that these costs are unallowable
under the investment management cost prohibition. 5. Other Arguments Orange County argued that several additional cost principles
provided affirmative authority in support of the consultant costs in spite
of guidelines and rules relied on by the Agency. In particular, Orange
County cited the Attachment B rules on professional service costs, accounting,
public relations costs and disbursing services costs, which state, respectively:
None of these rules supports Orange County. The provisions discussed above concerning allocability, general government expenses, and reasonableness take precedence over these more specific rules which merely state that certain categories of costs may be allowable if they are otherwise allocable and reasonable charges to a federal grant. As the introduction to Attachment B of A-87 provides:
Moreover, we question whether the provision on disbursing service costs is at all applicable here since the disbursement that occurred in this instance was to Orange County's creditors and not to the recipients or service providers of federal grant programs as would seem to be contemplated by the disbursing services provision. 6. The Arthur Anderson costs During the oral argument held in this appeal, the Agency suggested that some financial costs associated with payments to the Arthur Anderson accounting firm might have been properly charged to Orange County's indirect cost pool. Tr. at 53 - 54. These financial costs represented $1,568,778 of the disallowed amount. Orange County Ex. O at last page. At the Board's suggestion, the parties attempted to reach a settlement on this part of the disallowance. The parties subsequently conducted a lengthy exchange of information which resulted in agreement on a number of issues pertaining to the Arthur Anderson costs. The parties agreed that the Arthur Anderson costs should be divided into 44 separate activity code items as listed in Orange County Exhibit Y. Orange County withdrew its claims for four of the activity codes (006, 009, 014, 039). The parties then further agreed that activity code items 001, 004, 012, 013, and 020 "should be appropriately allocated on a dollar-weighted basis as between allowable vs. unallowable and unclaimed [Arthur Anderson] costs." Agency's June 15, 2000 letter, section IV. The Agency further agreed that seven activity code items were either allowable (019 and 038) or potentially allowable (005, 011, 041, 042, and 043) as charges that could be included in Orange County's 1996-97 countywide CAP. Id. section V. The Agency explained that these activity code items fell within the A-87 parameters of allowability for "accounting," "audit services," "personnel," "budgeting," and "electronic data processing", providing that Orange County provide additional information how these items benefitted federal programs. Id. The Agency drew a distinction between the disallowed code items as having been incurred as a result of Orange County's bankruptcy and being within the ambit of the guidelines and rules relied upon for the disallowance and those code items it found allowable or potentially allowable because the latter costs could have been incurred by Orange County in the improvement of its management and fiscal operations even if a bankruptcy had never taken place. As for the remaining 28 activity codes, the parties disagreed
on their allowability, largely repeating their general arguments on the
applicability of the A-87 standards to the consultant costs made in their
briefs and in the oral argument. We find that the charges reflected in the remaining 28 activity codes of the Arthur Anderson costs are not allowable costs to the federal grants at issue on the basis of the A-87 cost principle guidelines and rules discussed above with respect to the consultant costs as a whole. None of Orange County's arguments pertaining to these code items persuaded us that the cost items fell outside the ambit of these guidelines and rules. Orange County, moreover, failed to persuade us that the Agency acted unreasonably in determining that these cost items were incurred as a result of the bankruptcy proceedings. We therefore sustain the disallowance of the costs reflected in these activity codes. However, we direct the Agency to adjust the disallowance amount to reflect: 1) those five activity codes that the parties agreed should be allocated on a dollar-weighted basis; 2) the two activity codes the Agency has determined are allowable costs; and 3) the five "potentially allowable" code items after affording Orange County the opportunity to provide further information on these costs. Conclusion For the reasons discussed above, we sustain the disallowance in its entirety, subject to a reduction for several cost items associated with the Arthur Anderson charges. After affording Orange County with an opportunity to make any necessary further demonstration regarding the "potentially allowable" code items, the Agency should provide Orange County with a final calculation within 60 days of receipt of this decision, or within such additional time as the parties agree. If Orange County should disagree with the Agency's calculation of the reduction, Orange County may appeal the determination to the Board within 30 days receipt of the determination. |
|
|
|
JUDGE | |
Cecilia Sparks Ford M. Terry Johnson Donald F. Garrett |
|
FOOTNOTES | |
1. Orange County also argued that federal programs benefitted from the reduction in the County's operating costs that occurred as a result of the bankruptcy process. It was, however, Orange County's investment losses, and not the bankruptcy process per se, that made Orange County unable to honor its financial obligations and that necessitated the reduction of its operating costs. The ultimate and overriding purpose of the bankruptcy process was to allow Orange County to remain a viable entity when it became unable to meet the full cost of its obligations. It is indeed quite possible that Orange County may have been required to reduce the costs of its programs and operations to even a greater degree than it did if Orange County had not chosen the bankruptcy process it ultimately followed. 2. Indirect costs are those: (a) incurred for a common or joint purpose benefitting more than one cost objective, and (b) not readily assignable to the cost objectives specifically benefitted, without effort disproportionate to the results achieved. Att. A, � F. (Emphasis supplied.) |
|