Life to become more difficult for some defense contractors.

• Author: Erwin, Sandra I.
• Position: DEFENSE WATCH

When the Pentagon's outsourcing boom started in the 1990s, the practice was praised as a secret weapon in the fight against big government and public-sector inefficiency.

Almost two decades and two wars later, the pendulum has started to swing in the opposite direction--following a steady stream of studies, investigations and revelations in recent years of fraud, waste and abuse in military contracts.

In the current climate, it is not surprising to see much hand-wringing and unease within the industry about a perceived fraying relationship with its biggest customer. Some of the apprehension may be exaggerated, but certain worries are justified, insiders and legal experts warn. Not only is the government determined to take back the jobs it outsourced years ago, but it also plans to unleash its frustrations in the form of new rules and regulations.

Scrutiny is nothing new in the defense industry, but nonetheless contractors can expect "more aggressive auditing" and generally tighter enforcement of existing regulations, says John Chierichella, a partner in the government contracts and regulated industries practice at the Washington, D.C., law firm Sheppard, Mullin, Richter & Hampton LLP.

There are specifically two groups of contractors that are going to be the targets of far more inspection and oversight than they've been accustomed to. The first group is companies that have "cost-reimbursement" contracts, also known as "cost-plus." Under such arrangements, a contractor is paid for allowed expenses to a set limit, plus a stipulated profit margin.

By contrast, in fixed-price contracts, a company is paid a negotiated amount regardless of incurred expenses. These are not subject to as rigorous auditing as cost-plus contracts.

The other group of firms that the Pentagon is going to watch more closely is the "SETA" contractors, which are so named because they perform systems engineering and technical assistance work.

"I would expect reforms will aim at making life more difficult for contractors," Chierichella says.

The Defense Department has been under relentless political fire for lapses in oversight and an inability to control rampant costs. A recent management shakeup at the Defense Contract Audit Agency allegedly stemmed from accusations that the organization let contractors get away with hundreds of millions of dollars of incorrectly booked costs against government contracts.

"There are going to be more audits; they'll ask for more...