Stanford University News Service



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January 2, 1992

Yesterday, the Associated Press ran a wire story reporting that in a year-end statement President Donald Kennedy and Board of Trustees President James Gaither "warn that the Defense Department audit of government research costs from the 1980's may wind up costing the university up to $480 million." The statement is not accurate, but it has been printed in newspapers around the country.

The year-end statement was prepared for a Stanford publication, the Stanford Observer, that goes to 125,000 alumni and friends of the University. This statement reported on the events in 1991 related to the indirect cost controversy and on what might be expected as a major issue in 1992. The statement focused on the importance of contracts between Stanford and the government known as Memoranda of Understanding (MoUs). Without intending to predict what might happen or given any specific dollar number, the statement included the following phrase: "We are concerned that government auditors may be disregarding the MoUs and that, as a consequence, auditors' findings could allege that Stanford was overpaid during the 1980s by several hundred million dollars." The $480 million figure has never been given to Stanford by any government official. As far as Stanford knows, the $480 million dollars is a figure that has been given to the press by Mr. Paul Biddle, the Office of Naval Research representative on the Stanford campus, and that such a figure covers items other than indirect costs.

DCAA audit reports are advisory opinions submitted to the contracting agency, the Office of Naval Research. Such audit reports and the negotiations to resolve any disputed facts that may be contained in them are supposed to be confidential under law and government policy. Stanford's policy is not to comment on confidential matters under negotiation unless they are discussed in the press by government officials. Stanford does reserve the right to comment on matters that have been leaked by others.

To Stanford's knowledge, any DCAA audit reports that may have been completed recently are still within the normal process for evaluation and consideration within the government, and Stanford cannot comment on such reports.


President Donald Kennedy and Board of Trustees President James C. Gaither wrote the following year-end statement, discussing the indirect cost issue, to Observer readers.

As we look back on 1991 and forward toward 1992, we want to report to the Stanford family on the status of our relationship with the federal government.

Much of our effort in the past year has been devoted to reform of Stanford's financial administration and to our response to the government regarding indirect costs. We appointed a new university chief financial officer, who has installed a new management team and reorganized critical functions. Many of the 35 recommendations of Arthur Andersen & Co. to improve Stanford's internal controls have been implemented, and the remainder should be in place in another year. A new team of external auditors was selected after intensive competition, and is now on the job; 70 Stanford staff members and outside consultants are at work to resolve outstanding issues. All in all, it has been a massive effort - one that will extend into the coming year.

This reform effort establishes an essential foundation for improved business relations with the government as we move forward. But our attention now is focused on resolving the many outstanding issues - most notably, the final indirect cost negotiations for most of the years of the 1980s. Resolving them may present problems.

At the very heart of the matter is a set of contractual understandings jointly agreed to by the government and Stanford, and promulgated in the form of Memoranda of Understanding (MoUs). We are concerned that government auditors may be disregarding the MoUs and that, as a consequence, auditors' findings could allege that Stanford was overpaid during the 1980s by several hundred million dollars. We believe the MoUs are binding contracts and that such audit findings would be incorrect. Because of the importance of those MoU agreements, let me describe in broad outline why they were developed, what they are and why they are so important.

In 1979, the federal government issued a revised set of broad rules for indirect cost recovery at universities. Implementation of these complex new rules required many changes in the way we were then documenting and accounting for costs. The government's legally authorized and responsible official from the Office of Naval Research (ONR -- the agency with oversight responsibility for ensuring that the new rules were followed at Stanford) and Stanford officials, therefore, began to define and agree on business practices under the new rules and to document those agreements in written form.

These Memoranda of Understanding are binding contracts, formally signed by both the government and Stanford. In all, more than 100 such MoUs were entered into over the decade. They cover most of the important areas of business transactions related to indirect costs: for example, the allocation of utility costs, maintenance of equipment records, the allocation of library costs, calculation of administrative time and effort, principles for allocation of costs in service centers such as print and copying shops, signature authorization for certain expenditures, and many other essential accounting matters.

Some of the MoUs are associated with studies for allocating particular types of costs. These cost studies are important because government rules specify that, in the absence of a cost study, a rough approximation known as a "default" allocation method should be used. The default approach can grossly under-measure the University's true costs. For example, the default method for allocating utility costs requires that all square footage be treated equally -- that is, two buildings of equal square footage should be allocated equal shares of utility costs, regardless of the actual utility consumption of each building. Because it can be readily shown that research laboratories are much heavier utility users than classrooms, all major research universities conduct studies so that these costs can be more accurately allocated on the basis of actual usage. The difference between the undiscriminating default allocation of utility costs and the more accurate cost study allocation, which the government agreed to in an MoU, is substantial -- at Stanford, a difference of approximately $5 million in a typical recent year.

During the decade of the 1980s, therefore, both the government and Stanford relied on the MoUs to define and govern business practices related to indirect cost recovery. With the recent reviews and audits of Stanford's indirect cost system, the MoUs have come under criticism. Several months before the congressional hearing last March, at which the MoUs were criticized, Stanford and ONR agreed to a thorough review of each MoU. If the system of MoUs jointly developed by the government and Stanford was no longer a mutually agreed upon way to conduct business, Stanford was prepared and committed to move in an orderly manner to a different system for future years.

We, thus, were quite surprised last April when ONR abruptly cancelled all existing MoUs, effective at the beginning of our fiscal year, Sept. 1, 1990. That cancellation instantly wiped out the basis on which we had been conducting business, documenting costs and maintaining records. No transition period was provided to establish new business arrangements. ONR then unilaterally reduced Stanford's indirect cost rate from 70% to 55.5% -- a result that flowed directly from the cancellation of the MoUs. Stanford protested these actions and has filed an appeal with the Armed Services Board of Contract Appeals to obtain relief from these decisions. Stanford will be seeking the sum lost in 1991 due to ONR's actions, at least $20 million.

Although there will be many matters to resolve in the coming months, the dominant issue will be that of the MoUs. The MoUs have not been cancelled for the period before Sept. 1, 1990. They remain the basis against which Stanford's books should be audited for the unresolved years of the 1980s. We are concerned, however, that the Defense Contract Audit Agency may not be auditing our books for those years according to the MoUs, but may instead be attempting to construct default methodology calculations.

Stanford is on solid legal ground with respect to the MoUs. We have documented for the government (and will make available to anyone who wishes a copy) our position on the validity of the MoUs. This issue is now before a tribunal for legal resolution. At its core, the issue is simple and fundamental: Stanford entered into these contractual agreements with the government in good faith, carried them out fairly and relied on them for many years. The government cannot now retroactively ignore those agreements to which is was a party and choose to apply different standards.

It might be argued that, despite the government's unfairness in arbitrarily cancelling its agreements with us, Stanford should not consider legal action. It is, after all, our government, and we have received important institutional benefits from the public support of Stanford research that has flowed through the partnership.

But Stanford has, in the past - as have many citizens - disagreed with the government on a matter of principle. When that has happened - as in the case of the proposed limitations on the freedom of scholars to publish their results or of attempts to block access to research projects - Stanford has been willing to uphold principle and oppose the government. We believe this is just such a case, for there surely can be no principle more fundamental than this: that the parties to an agreement are mutually bound by it.

Stanford, you may be assured, will live up to its part of these agreements and is fully committed to resolving all the outstanding issues in a way that is fair to the university and to the taxpayers. The public interest in this matter involves much more than proper accounting. The research venture at Stanford is of enormous public benefit. It is in the nation's interest that we retain the university's research capacity - and the principles of fairness and partnership with the government under which it has flourished.

We will continue to report to you from time to time on this matter. We want very much to receive your advice and criticism; during these challenging times, we especially value your support for the university.

-Donald Kennedy and James C. Gaither


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