‘They overreached’: Amid industry worry, new Feinberg memo tweaks accounting regime

WASHINGTON — A memo signed out by Deputy Secretary of Defense Stephen Feinberg this week is the latest in the Pentagon’s attempt to streamline defense acquisition, but also serves as a corrective to a previous declaration that had concerned industry, analysts tell Breaking Defense.

Tuesday’s memo, titled “Fostering One Strong Industrial Base,” primarily targets the Cost Accounting Standards (CAS) used across government, encouraging them to be replaced instead with the Generally Accepted Accounting Principles (GAAP) used in the commercial sector.  

“We will accept GAAP-based accounting across all contracts to the maximum extent the law permits,” Feinberg writes. “Transparency and partnership run both ways: the Department opens its buying to market forces, and when asked, industry shares the cost and pricing information it already keeps.”

While Feinberg said the move was part of an effort to “completely transform and modernize our contract cost and pricing ruleset,” analysts said it also appeared to be something of a reversal for the Pentagon in the wake of a contentious Aug. 18 missive that floated more aggressive Pentagon oversight of pricing practices. In the wake of that memo, some in industry worried the Pentagon was attempting to get deep into proprietary info or financial information, a particularly sensitive issue for the kind of non-traditional firms the department has been courting.

The August memo “was received very poorly, and I think no one really understood what they meant, I think was the challenge,” said Jerry McGinn, director of the Center for the Industrial Base at CSIS and a former senior defense acquisition official. “And that is what they’re doing here — they’re tying it back to the [industrial base] strategy and what they’d like to do, and they articulate that it’s a process.”

Added Bill Greenwalt of the American Enterprise Institute, “The first memo was an attempt to applying traditional compliance oversight to everyone including commercial and non-traditional companies. That would have had serious ramifications to the firms trying to disrupt the status quo. I think they got the message on that, that those firms weren’t happy and could exit the market.”

In the new memo, Feinberg defended the August order as “essential to ensure companies at every tier are treated fairly.” But he also appeared to offer industry more options, analysts said.

“It looks like they may have realized they overreached with the first memo, and they’re now trying to limit the damage,” Greenwalt, who worked on acquisition reform as a Senate aid for years, continued. “This is a Pentagon that doesn’t want to admit they made a mistake, and the first memo was a huge mistake, so it’s progress they’re at least working to change things.”

‘A Way For Traditionalists To Become Non-traditional’

CAS has traditionally been used to help audit government-only sole source contracts. While used across government, the Pentagon, with its outsized budget, has naturally had the lion’s share of CAS-covered contracts.

The problem is that right now, there is effectively a bifurcated system: major defense firms have to undergo CAS standards due to their participation in CAS-covered contracts, while many non-traditional firms do not. McGinn said that only around 7 percent of companies that do business with the Pentagon are CAS-compliant, but those 7 percent accounted for around $300-$400 billion that was obligated last year, as they cover all the major defense programs like carriers, subs or fighter jets.

When Defense Secretary Pete Hegseth launched a major acquisition reform effort last November, part of the goal was to streamline the system. That effort bled through in Feinberg’s August memo as well, which Greenwalt described as attempting to create one system for all contractors. But Greenwalt said the DoD chose the wrong way to go about it, by increasing oversight and pushing everyone more towards something resembling CAS requirements.

In contrast, this week’s memo effectively says that the Pentagon will attempt to get off CAS as the default.

“The first memo seemed like it was trying to get everyone into one system, but it did that by doubling down on the government-unique ideas and oversight, which was a mistake,” Greenwalt said. “This language seems to lean towards opening up commercial-type systems to everyone, or at least the option of that to everyone.”

It won’t be quick: By law, the Pentagon will still need to apply CAS to sole source development programs until it can work within the government-wide CAS Board to change the standards of CAS to GAAP.

In the meantime, the Pentagon will attempt to use a series of existing authorities to constrain CAS on commercial and new entrants. The goal will be to apply CAS on a program-by-program basis, and attempt to limit CAS applicability on a company-by-company basis as it currently is.

In an investor note, Roman Schweizer of TD Cowen noted that while the August memo was focused on pricing transparency, this memo “seems less about imposing new oversight & more about removing barriers that discourage companies from doing business” with the Pentagon.

Still, shifting to a new model raises questions, according to Alek Jovovic, also of CSIS.

“What are the business implications of transitioning from CAS compliant companies to CAS compliant programs? What impact does that have on companies? I think that’s a critical element of the memo, but how they’re going to implement this change it is the question,” he said.

Said Greenwalt, “It looks like they are providing a way for traditionalists to become non-traditional depending on what contracts they pursue. That’s an interesting new shift and will require a lot of thought by the companies on corporate restructuring and the CAS board to figure out how to convert from CAS into GAAP accounting.”

Sorting out how this will all work will be especially important with “things like the Family of Affordable Mass Munitions, these new kind of programs, low-cost interceptors,” McGinn said.

Some Pricing Info Concerns Remain

Early reaction from industry seems cautiously optimistic. A statement from Eric Fanning of the Aerospace Industries Association, a major defense trade group, said, “Many of the reforms outlined in this memorandum, including streamlining business systems requirements and continuing the shift from Cost Accounting Standards toward Generally Accepted Accounting Principles, reflect priorities AIA has long supported and helped advance.

“At the same time, some aspects, particularly continued demands for extensive cost and pricing data, could undermine the Department’s broader objective of attracting more companies, capital, and innovation into the defense industrial base,” Fanning said.

Wrote Schweizer, “We believe there could still be some potential negatives for [companies] in the implementation and adoption. We also think Congress and industry will want input into how the changes are enacted — we do not see the new memo as the final word on this subject.”

McGinn agreed this will not be the last word, stressing that the memo is best thought of not as a standalone, dramatic change, but rather as part of a continuum of reform efforts being pursued by the Trump Pentagon.

“It’s very much in line with the administration’s priorities, but it’s a journey, I think,” he said.