HCFA Extended Its Contract With Accounting Firm Implicated in Major Fraud
(Correspondence, 10/31/2000, GAO/GAO-01-136R).

Concerns have been raised about the Health Care Financing
Administration's (HCFA) decision to extend a contract with an accounting
firm that has been implicated in major fraud. KPMG's contract with HCFA
included annual options to extend performance that could be exercised at
HCFA's will. Although information on the fraud investigation was
available to HCFA staff at various levels, the information was not used
to make reasoned contracting decisions. If HCFA had considered the
information and documented its decision to extend KPMG's contract, it
could have minimized concerns over the appropriateness of its decision.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  GAO-01-136R
     TITLE:  HCFA Extended Its Contract With Accounting Firm Implicated
	     in Major Fraud
      DATE:  10/31/2000
   SUBJECT:  Fraud
	     Contract oversight
	     Investigations by federal agencies
	     Quality assurance
	     Contract extensions
	     Contract performance
IDENTIFIER:  Medicare Program
	     HCFA Audit Quality Review Program

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GAO-01-136R

GAO-01-136R HCFA Contracted With Firm Implicated in Fraud

United States General Accounting Office Washington, DC 20548

October 31, 2000 The Honorable Thomas Bliley Chairman Committee on Commerce
House of Representatives

Subject: HCFA Extended Its Contract With Accounting Firm Implicated in Major
Fraud

Dear Chairman Bliley: This letter responds to your June 16, 2000, request
that we investigate the Health Care Financing Administration's (HCFA)
oversight of contractors in its Audit Quality Review Program. That program
reviews the work of Medicare auditors. As such, it entails checking whether
Medicare auditors have done their work appropriately to detect improper or
fraudulent charges. In particular, you expressed concern with the
circumstances surrounding KPMG's 1 performance of a national audit quality
review contract, given difficulties the firm has encountered since the
contract award in September 1997.

We conducted our investigation from June 2000 through mid- October 2000 in
accordance with quality standards for investigations as set forth by the
President's Council on Integrity and Efficiency. We interviewed officials
and reviewed documents from HCFA, the Department of Health and Human
Services, the Federal Bureau of Investigation, and the Department of
Justice. We also spoke with attorneys representing KPMG.

In brief, during its performance of the HCFA audit quality review contract
from September 1997 to September 2000, KPMG was implicated in a significant
Medicare fraud case against its client, Columbia/ HCA. Specifically, KPMG
advised Columbia/ HCA on preparing cost reports whose submission led to
criminal and civil fraud charges against Columbia/ HCA. Two Columbia/ HCA
executives were convicted of conspiracy and criminal fraud in July 1999.
Columbia/ HCA has also agreed to pay the government approximately $750
million in partial settlement of the civil fraud claims. Senior HCFA
officials and officials in the General Counsel's office of the Department of
Health and Human Services were in a position to be generally aware of
allegations that Columbia/ HCA engaged in fraud and that KPMG contributed

1 KPMG was formerly known as KPMG Peat Marwick.

GAO- 01- 136R HCFA Contracted With Firm Implicated in Fraud Page 2 to its
client's improper actions. 2 Before September 1998, when HCFA exercised an

option to extend KPMG's contract performance for another year, these
officials either knew or should have known that civil and criminal actions
were pending in the Columbia/ HCA matter. Moreover, these same officials
knew or should have known that, as an audit quality review contractor, KPMG
would be responsible for reviewing transactions that were of the same type
as transactions about which KPMG had advised Columbia/ HCA. Finally, the
HCFA contracting officer responsible for the contract with KPMG had actual
knowledge of a separate civil suit against KPMG that also made serious and
credible allegations of fraud related to KPMG's work for Columbia/ HCA. 3
The contracting officer did not advise her supervisor about this information
and did not retain relevant documents in the contract file.

KPMG's contract with HCFA included annual options to extend performance that
could be exercised or not at HCFA's sole discretion. The Federal Acquisition
Regulation (FAR) does not require that a contracting agency take action to
end a contract with a contractor accused of fraud; but as regards exercising
the option to extend, HCFA had complete discretion as to what action to take
in response to KPMG's situation. Although much information was available to
HCFA staff at various levels, the information was not used to make reasoned
contracting decisions. As a result, HCFA extended KPMG's contract in the
fall of 1998 and again in September 1999 without considering the impact the
fraud allegations would have on KPMG's ability to provide audit quality
review services. In one instance, the lack of information resulted in HCFA
issuing KPMG a task order to perform audits at a firm employing a key
prosecution witness in the criminal trial of the Columbia/ HCA executives.

Finally, senior HCFA officials should have used the information that was
available to make an informed decision about KPMG's continued performance.
If those officials had done so, HCFA might still have decided to extend
KPMG's audit quality review contract and remained consistent with the FAR,
which confers wide discretion on the contracting agency in these
circumstances. However, the decision would have been reasoned and supported;
and it would have minimized embarrassment over the decision. Furthermore,
HCFA could have avoided the inappropriate situation concerning a task order
for auditing the firm that employed a key witness against Columbia/ HCA and
KPMG, if HCFA officials had communicated information about the case to
employees who needed to know in order to administer the contract.

Background

On September 15, 1997, HCFA awarded Indefinite Delivery/ Indefinite Quantity
(ID/ IQ) contracts to KPMG and four other accounting firms to perform audit
services under HCFA's Audit Quality Review Program. The contracts guaranteed
each of the five contractors a minimum amount of business, with work
delineated by means of task orders. The initial contracts covered 1 year;
but each one permitted HCFA, at its

2 Some particulars of Columbia/ HCA's and KPMG's questioned accounting
practices were reported in the news media as early as Dec. 1997. See Kurt
Eichenwald, “Health Care's Giant: Artful Accounting Hospital Chain
Cheated U. S. On Expenses, Documents Show,” New York Times, Dec. 18,
1997, p. A1. 3 This litigation is still pending.

GAO- 01- 136R HCFA Contracted With Firm Implicated in Fraud Page 3 sole
discretion, to exercise an annual option to extend the effective period of
the

contract for 4 additional years. At the time of the contract award in
September 1997, HCFA determined that KPMG was responsible. In the judgment
of the contracting officer, KPMG was found to possess the resources and
integrity needed to perform the contract. In May 1998, after award but
before the time to exercise the first option to extend the contract for an
additional performance year, KPMG was implicated in a multimillion- dollar
Medicare fraud case against its client, Columbia/ HCA. By September 1999,
the date for exercising the second option to extend contract performance,
many details of KPMG's alleged part in the fraud had been publicly
disclosed.

Responsibility Determinations and Contract Extension

Before awarding a government contract, the FAR requires the contracting
officer to make an affirmative determination that the prospective contractor
is responsible. 4 Among other factors, a responsibility review includes an
examination of the prospective contractor's integrity and business ethics. 5
A contracting officer has considerable latitude to exercise judgment and
discretion in finding a contractor to be responsible or not. 6 Issues, such
as serious and credible accusations that an audit firm had aided and abetted
a client's fraud, could certainly reflect on a firm's responsibility to
perform other audit contracts. Consistent with the FAR, a contracting
officer would potentially be justified in declining to make a positive
responsibility determination on that basis. 7 On the other hand, because of
the discretion vested in the contracting officer, similar circumstances
would not necessarily preclude a finding of responsibility, 8 provided that
the firm had not been suspended or debarred. 9

The FAR does not require the contracting officer to reexamine responsibility
during the contract's performance. 10 Neither does it require making a
further determination of responsibility before extending performance by
exercising an option to renew the contract for another year. 11 However,
because the exercise of an option is at the sole discretion of the
contracting agency, any relevant factors, including new information

4 48 C. F. R. sect. 9. 103 (2000). 5 48 C. F. R. sect. 9. 104- 1 (2000). 6 See, e.
g., John C. Holland Enterprises, B- 216250, Sept. 24, 1984, 84- 2 CPD para. 336.
(A contracting

officer's responsibility determination is not reviewable except for
allegations of fraud or bad faith on the part of the contracting officer or
in the event of a failure to apply a definitive responsibility criterion.) 7
See, e. g., Standard Tank Cleaning Co., B- 245364, Jan. 2, 1992, 92- 1 CPD para.
3. (Violations and alleged

violations of state environmental laws justified the contracting officer's
finding that the firm was not responsible to clean out fuel storage tanks on
surface ships.) 8 See, e. g., ProServe Corp., B- 247948, B- 247948. 3, Oct.
5, 1992, 92- 2 CPD para. 225. (A firm's prior fraud in

performing a government contract did not require a determination of
nonresponsibility.) 9 Sabreliner Corp., B- 242023, B- 242023.2, Mar. 25,
1991, 91- 1 CPD para. 326. (Inclusion on an agency's

“Alert List” of contractors with responsibility concerns does
not require a finding of nonresponsibility, absent suspension or debarment.)
10 Even a contractor that is debarred while performing a contract may be
permitted to continue

performance. However, contracts may not be extended while debarment
continues, absent compelling reasons. 48 C. F. R. 4 sect. 9. 405- 1 (2000). 11
E. Huttenbauer & Son, Inc., B- 258028, B- 258028. 3, 95- 1 CPD para. 148.

GAO- 01- 136R HCFA Contracted With Firm Implicated in Fraud Page 4 that
might raise responsibility concerns if disclosed at the time of award, can
be

taken into account in making that decision. In this case, HCFA found KPMG to
be responsible prior to the award of the ID/ IQ contract. That determination
is not in question. At the time of the award, information regarding the
Columbia/ HCA fraud case was not available. HCFA did not reexamine
responsibility when it exercised the options, but there was no requirement
to address the issue again. However, the allegations that KPMG contributed
to Columbia/ HCA's fraudulent billing actions had been disclosed to HCFA in
May 1998 and were public knowledge by the summer of 1999. In our view, HCFA
could reasonably have declined to exercise the options because of the
release of information that had a negative bearing on the contractor's
integrity. Alternatively, it could just as reasonably have exercised the
options based on the fact that KPMG employees had not been indicted and the
firm had not been proven to be culpable in the Columbia/ HCA case. 12
Nevertheless, HCFA did not make a reasoned decision to extend the
performance, because those employees who actually made the decision either
did not have or did not share all available and relevant information.

HCFA Should Have Considered Information About KPMG's Involvement in the
Columbia/ HCA Matter

At the criminal trial 13 of four Columbia/ HCA executives, two individuals
from KPMG- a KPMG partner and a management employee- were publicly
identified as unindicted co- conspirators in Columbia's fraudulent activity.
Two Columbia/ HCA executives were subsequently convicted of conspiracy and
criminal fraud in July 1999. 14 The proceedings in open court revealed a
significant amount of supporting testimony and documentation concerning
KPMG's alleged role in the fraud, and the information was reported widely in
the press. Further, a senior HCFA official testified at the trial. This
official had notified HCFA management in writing on at least three occasions
that this fraud case was one of the top five fraud cases that HCFA should
actively monitor. In addition, Columbia/ HCA agreed to pay approximately
$750 million to the government as a partial settlement of civil fraud
claims.

In addition, in May 1998, the Department of Justice mailed copies of a Qui
Tam complaint 15 to the Inspector General and the General Counsel of the
Department of Health and Human Services. The Qui Tam complaint alleged that
KPMG had assisted in preparing false cost reports for Columbia/ HCA. The
Inspector General received that document and logged it in, but the Office of
the General Counsel claims never to have received its copy. However, in July
or August 1998, a copy of the complaint was

12 Other litigation against KPMG is still pending. 13 United States v. Jay
A. Jarrell, et al., S97- 52- CR- FTM- 24D (M. D. Fla.). 14 The jury was not
able to reach a verdict for one defendant. That individual agreed to a
pretrial

diversion, meaning essentially that he accepted legal responsibility for
criminal actions, provided the Department of Justice would not retry him.
The fourth defendant was acquitted. 15 The False Claims Act (31 U. S. C. sect.sect.
3729 – 33 (1994)) permits private individuals to bring alleged false

claims to the government's attention and request the Department of Justice
to prosecute. Such requests are called Qui Tam actions, and the private
party is known as the relator. When a Qui Tam action concludes successfully,
the statute awards a percentage of the government's recovery to the relator.

GAO- 01- 136R HCFA Contracted With Firm Implicated in Fraud Page 5 provided
anonymously to the HCFA contracting officer responsible for the KPMG

ID/ IQ contract. 16 KPMG, through its attorney, denied the allegations
against the firm and stated that no KPMG employees were indicted or
convicted in the Columbia/ HCA case. He pointed out that KPMG still employs
the two employees named as unindicted co- conspirators. The Qui Tam
proceeding against KPMG is continuing, but additional information is not
publicly available.

HCFA Failed to Use Available Information

All HCFA contracting staff that we interviewed agreed that the information
about KPMG and its alleged part in the Columbia/ HCA case was critically
important to making reasoned and informed decisions about continued
performance and the propriety of issuing specific task orders. None of these
employees had the full benefit of information that was or should have been
available within the agency.

The contracting officer who handled the first two contract extensions told
us that in December 1997 she read a news account of Columbia/ HCA's alleged
fraud and questions about KPMG's role in preparing questionable cost claims.
17 She said, however, that she had not taken it seriously. Later, in July or
August 1998- before exercising the first option- she found a copy of the Qui
Tam complaint against KPMG, which was still under court seal, on her desk.
While she was not able to determine who had provided her this document, she
recognized that it contained serious allegations and that it could affect
KPMG's continued performance. She did not discuss this matter with her
supervisor, but she was concerned enough to contact the KPMG officials
responsible for the ID/ IQ contract. These officials, although
“embarrassed,” provided assurances that the unit performing the
ID/ IQ contract was not involved in any way in the alleged fraud.

When the contracting officer exercised the option, she apparently relied on
those assurances and on an observation that KPMG's actual performance of the
ID/ IQ contract was fully satisfactory. However, she did not document the
contract file to inform others of the information she had obtained. When the
contracting officer left her position in February 2000, that information was
effectively lost. The current contracting officer told us that she had not
known about KPMG's possible involvement in the Columbia/ HCA fraud prior to
our interview with her.

HCFA's contracting officers told us that they rely on Project Officers,
Government Task Leaders, and other HCFA employees from the program areas to
provide information on potential contractors prior to making contract
decisions. In this instance, neither the Project Officer nor the Government
Task Leader provided any information to the contracting officers prior to
the yearly contract extensions. Such dependence on receiving information
from others contributed to KPMG's contract

16 We were not able to establish how the document came to be on HCFA's
premises. The Inspector General stated that her office did not provide a
copy to anyone in HCFA because the cover letter from the Department of
Justice indicated that the General Counsel had also been mailed a copy. 17
Kurt Eichenwald, “Health Care's Giant: Artful Accounting - Hospital
Chain Cheated U. S. On

Expenses, Documents Show,” New York Times, Dec. 18, 1997, p. A1.

GAO- 01- 136R HCFA Contracted With Firm Implicated in Fraud Page 6
extensions. This allowed KPMG to continue to review some transactions that
were of

the same type as those that it had advised Columbia/ HCA about and that had
become involved in the criminal trial and civil suits against Columbia/ HCA.

Meanwhile, the contracting officer who extended the contract did not share
information she had about the Qui Tam proceeding with the contract
administration personnel. As a result, the contract administration staff
unknowingly issued a task order to KPMG to perform audit services at the
same firm that employed the Qui Tam relator, who was a key witness against
both Columbia/ HCA and KPMG. When the Department of Justice requested that
HCFA remove KPMG from that task order, HCFA complied. Apparently, no one
from HCFA followed up with the Justice Department to learn the reason for
that request, because information about the allegations against KPMG still
was not disseminated to appropriate HCFA staff.

Later, in March 2000, a HCFA audit of Columbia/ HCA disclosed the KPMG
involvement with the Columbia/ HCA case. HCFA officials maintain that this
was the first notice that HCFA had of the apparent and actual conflict of
interest in KPMG's continued performance of the audit service contract.

In September 2000, HCFA cited lack of funds to continue performance of any
of the contracts under its Audit Quality Review Program. For this reason,
the agency declined to exercise the option to extend the KPMG contract and
took similar action on the other four contracts for the 2001 performance
year.

---- As arranged with your office, unless you announce its contents earlier,
we plan no further distribution of this letter until 30 days after the date
of the letter. At that time, we will make copies of the letter available to
interested congressional committees and agency officials and to others on
request. If you have any questions about this investigation please call me
at (202) 512- 7455 or Assistant Director William Hamel at (202) 512- 6722.
Special Agent Andrew O'Connell was a key contributor to this investigation.

Sincerely yours, Robert H. Hast Managing Director Office of Special
Investigations

(600661)
*** End of document. ***