Defense Federal Acquisition Regulation Supplement: Definition of Material Weakness (DFARS Case 2021-D006)

<RULE> DEPARTMENT OF DEFENSE <SUBAGY>Defense Acquisition Regulations System</SUBAGY> <CFR>48 CFR Parts 202, 215, 234, 242, 244, 245, and 252</CFR> <DEPDOC>[Docket DARS-2024-0020]</DEPDOC> <RIN>RIN 0750-AL25</RIN> <SUBJECT>Defense Federal Acquisition Regulation Supplement: Definition of Material Weakness (DFARS Case 2021-D006)</SUBJECT> <HD SOURCE="HED">AGENCY:</HD> Defense Acquisition Regulations System, Department of Defense (DoD). <HD SOURCE="HED">ACTION:</HD> Final rule. <SUM> <HD SOURCE="HED">SUMMARY:</HD> DoD is issuing a final rule amending the Defense Federal Acquisition Regulation Supplement (DFARS) to implement sections of the National Defense Authorization Acts for Fiscal Year 2021 that defines the term “material weakness” for Government evaluation of contractor business systems. The term “material weakness” replaces the term “significant deficiency.” </SUM> <EFFDATE> <HD SOURCE="HED">DATES:</HD> Effective January 17, 2025. </EFFDATE> <FURINF> <HD SOURCE="HED">FOR FURTHER INFORMATION CONTACT:</HD> Mr. Jon Snyder, telephone 703-945-5341. </FURINF> <SUPLINF> <HD SOURCE="HED">SUPPLEMENTARY INFORMATION:</HD> <HD SOURCE="HD1">I. Background</HD> DoD published a proposed rule in the <E T="04">Federal Register</E> at 89 FR 53561 on June 27, 2024, to implement section 806 of the National Defense Authorization Act (NDAA) for Fiscal Year (FY) 2021 (Pub. L. 116-383), which amends section 893 of the NDAA for FY 2011 (Pub. L. 111-383). Section 893 of the NDAA for FY 2011 requires a program for the improvement of contractor business systems and provides for DoD approval or disapproval of contractor business systems. Section 806 of the NDAA for FY 2021 defines the term “material weakness”, which replaces the term “significant deficiency.” Three respondents submitted public comments in response to the proposed rule. <HD SOURCE="HD1">II. Discussion and Analysis</HD> DoD reviewed the public comments in the development of the final rule. A discussion of the comments and the changes made to the rule as a result of those comments is provided, as follows: <HD SOURCE="HD2">A. Summary of Significant Changes From the Proposed Rule</HD> There are no significant changes from the proposed rule. <HD SOURCE="HD2">B. Analysis of Public Comments</HD> <E T="03">Comment:</E> A respondent recommended DoD add experience requirements for administrative contracting officers that issue decisions related to business system deficiencies. The respondent also recommended clarifying that, although the terminology has changed, a warranted official is required to make the determination of findings of the audit or review. <E T="03">Response:</E> Federal Acquisition Regulation 1.603 establishes the requirements for the selection, appointment, and termination of appointment for contracting officers. Section 806 does not require administrative contracting officers that issue decisions related to business system deficiencies to have a certain amount of experience. DFARS 242.7502 specifies that the cognizant contracting officer, in consultation with the auditor or functional specialist, shall determine the acceptability of a contractor's accounting system and approve or disapprove the system and pursue correction of any deficiencies as required. As such, it is not necessary to make the recommended changes. <E T="03">Comment:</E> A respondent recommended adding a matrix at DFARS 242.7000 that aligns the types of Generally Accepted Accounting Systems internal control findings with the Defense Contract Management Agency (DCMA) corrective action request levels. <E T="03">Response:</E> The creation of a reference matrix to pre-establish a particular level of a corrective action request would constrain the cognizant contracting officer's ability to administer and oversee contracts. Therefore, this recommendation is not implemented in the final rule. <E T="03">Comment:</E> A respondent recommended that DoD discontinue the use of or replace earned value management with a “cash on delivery” payment system. A respondent recommended that DoD consider a small business exemption from the DFARS business system clauses because they are complex systems that most small businesses cannot afford to invest the human and financial capital into supporting. A respondent recommended that DoD implement an inflation adjustment for each business system for fiscal year 2025 to mitigate the impacts of inflation on small businesses. <E T="03">Response:</E> These comments are outside the scope of this rule. Section 806 does not authorize DoD to discontinue the use of or replace earned value management, nor does it authorize DoD to establish a small business exemption or an inflation adjustment. Inflation adjustments are made in accordance with 41 U.S.C. 1908. <HD SOURCE="HD2">C. Other Changes</HD> The clause at DFARS 252.245-7003, Contractor Property Management System Administration, is amended to update the paragraph references to align with the changes made to the clause. At DFARS 242.7203(c)(2)(ii)(A) “deficiency” is changed to “weakness or deficiency”. In addition, at DFARS 215.407-5-70(d)(1) and 244.305-70(c)(1) “weakness and deficiencies” is changed to “weakness or deficiencies”. <HD SOURCE="HD1">III. Applicability to Contracts at or Below the Simplified Acquisition Threshold (SAT), for Commercial Products (Including Commercially Available Off-the-Shelf (COTS) Items), and for Commercial Services</HD> This final rule amends the clauses at DFARS 252.215-7002, Cost Estimating System Requirements; 252.234-7002, Earned Value Management System; 252.242-7004, Material Management and Accounting System; 252.242-7005, Contractor Business Systems; 252.242-7006, Accounting System Administration; 252.244-7001, Contractor Purchasing System Administration—Basic and Alternate I; and 252.245-7003, Contractor Property Management System Administration. However, this final rule does not impose any new requirements on contracts at or below the SAT, for commercial products, including COTS items, or for commercial services. Applicability of the clauses to acquisitions at or below the SAT, to acquisitions of commercial products including COTS items, and to acquisitions of commercial services remains unchanged. <HD SOURCE="HD1">IV. Expected Impact of the Rule</HD> Presently, the DFARS includes a definition of “significant deficiency” in the context of DoD evaluation of contractor business systems. “Significant deficiency” is defined as “a shortcoming in the system that materially affects the ability of officials of the Department of Defense to rely upon information produced by the system that is needed for management purposes.” This final rule replaces the term “significant deficiency” in the DFARS with the term “material weakness,” defined as a deficiency or combination of deficiencies in the internal control over information in contractor business systems, such that there is a reasonable possibility that a material misstatement of such information will not be prevented, or detected and corrected, on a timely basis. A reasonable possibility exists when the likelihood of an event occurring is probable or more than remote but less than likely. This definition of “material weakness” provides more detail and clarity both to DoD and to industry in the context of evaluating contractor business systems compared to the definition of “significant deficiency.” This definition of “material weakness” also aligns with generally accepted auditing standards. Therefore, this rule will both create consistency with generally accepted auditing standards and minimize confusion about the seriousness of deficiencies, which will aid both DoD and industry. <HD SOURCE="HD1">V. Executive Orders 12866 and 13563</HD> Executive Orders (E.O.s) 12866 and 13563 direct agencies to assess all costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, distributive impacts, and equity). E.O. 13563 emphasizes the importance of quantifying both costs and benefits, of reducing costs, of harmonizing rules, and of promoting flexibility. This is not a significant regulatory action and, therefore, was not subject to review under section 6(b) of E.O. 12866, Regulatory Planning and Review, as amended. <HD SOURCE="HD1">VI. Congressional Review Act</HD> As required by the Congressional Review Act (5 U.S.C. 801-808) before an interim or final rule takes effect, DoD will submit a copy of the interim or final rule with the form, Submission of Federal Rules Under the Congressional Review Act, to the U.S. Senate, the U.S. House of Representatives, and the Comptroller General of the United States. A major rule under the Congressional Review Act cannot take effect until 60 days after it is published in the <E T="04">Federal Register</E> . The Office of Information and Regulatory Affairs has determined that this rule is not a major rule as defined by 5 U.S.C. 804. <HD SOURCE="HD1">VII. Regulatory Flexibility Act</HD> A final regulatory flexibility analysis has been prepared consistent with the Regulatory Flexibility Act, 5 U.S.C. 601, <E T="03">et seq.</E> and is summarized as follows: This rule is necessary to implement section 806 of the National Defense Authorization Act (NDAA) for Fiscal Year (FY) 2021 (Pub. L. 116-283). Section 806 amends section 893 of the NDAA for FY 2011 (Pub. L. 111-383), which requires a program for the improvement of contractor business systems and provides for DoD approval or disapproval of contractor business systems. Section 806 of the NDAA for FY 2021 replaces the term “significant deficiency” with “material weakness” and defines the term “material weakness.” The objective of the rule is to introduce the term “material weakn ━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━ Preview showing 10k of 77k characters. 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