Health Pro, Inc., DAB No. 574 (1984)

GAB Decision 574
Docket No. 84-80

September 7, 1984

Health Pro, Inc.;
Ballard, Judith; Settle, Norval Ford, Cecilia


Health Pro, Inc. (Grantee) appealed a decision by the Health Care
Financing Administration (Agency) to disallow $5,000 claimed as
consultant fees under a Professional Standards Review Organization
(PSRO) grant. The disallowance followed the recommendations contained
in an Audit Report for the grant year that ended December 31, 1981
(Audit Control No. 01-35009).

Grantee employed its former executive director as a consultant at a
rate of $500 per day for ten days, resulting in a total charge to the
grant of $5,000. The Agency disallowed this cost and concluded that (1)
the consulting services were neither reasonable nor necessary to the
objectives of the grant, and (2) there was little documentation or
explanation of the consultant's specific activities to justify the
charge to federal funds. Additionally, the Agency found that the fee
was unreasonable in amount. Grantee argued that, considering its
circumstances at the time it contracted for the consultant services, it
had exercised prudent judgment in incurring this cost.

For the reasons stated below, we reverse the decision in part, uphold
it in part, and remand for further Agency action. We have upheld the
disallowance in relation to the amount of the fee, because the record
shows the fee paid was not justified. However, we have also determined
that the record shows the consultant services themselves were not
unreasonable. Therefore, we return this case to the Agency for
determination of a reasonable amount for the consultant services.

This decision is based on the parties' written submissions and on the
tape of a conference call held pursuant to the expedited procedures at
45 CFR 16.12 (1983).

(2) Background

The 1972 Amendments to the Social Security Act provide for the
creation of PSROs, administered and controlled by local physicians, and
designed to involve local practicing physicians in the review and
evaluation of health care services covered under Medicare, Medicaid, and
the Maternal and Child Health programs. (Title XI, Part B, of the Act.)
PSROs are responsible in specifically designated geographic areas for
assuring that the health care paid for under these programs is medically
necessary and consistent with professionally recognized standards of
care. The PSROs also review whether the health services are provided at
the level of care which is most economical, consistent with the
patient's medical care needs. The PSROs are responsible for developing
and operating a quality assurance system based on peer review of the
quality and efficiency of services and continuing education.

The record shows that in the fall of 1981 Grantee's program entered a
period of transition; Grantee was losing its executive director of six
years and instituting major changes in its review system. On August 24,
1981, Grantee's former executive director entered into a contract with
the president of Grantee's Board of Trustees to serve as a consultant
between September 1, 1981 and December 31, 1981. The former executive
director agreed to provide 10 days of consultation and be reimbursed at
the rate of $500 per day.

The Audit Report questioned the allowability of the consultant fee
because Grantee had not demonstrated why the consultation services were
needed, what specific activities were to be performed, why the services
could not be procured through the organization that employed the former
executive director, or how the length of the contract and rate of
reimbursement were determined. The disallowance letter stated that the
consultant fee was unallowable because it violated OMB Circular A-122,
Attachment A, A.3 in that it was not reasonable or necessary for the
objectives of the grant.

The Agency's brief asserted that if Grantee had observed the
provisions of OMB Circular A-122 Attachment A, A.6, Grantee would have
sought "a written agreement with the cognizant or awarding agency in
advance." Additionally, the Agency brief asserted that to the extent
that the provisions of OMB Circular A-122, Appendix B, Section 34,
Professional Service (3) Costs, are applicable to consultant services,
the fees charged were unallowable when assessed under the following
factors:

* The nature and scope of the service rendered in relation to the
service required.

* The necessity of contracting for the service, considering the
organization's capability in the particular area.

* Whether the service can be performed more economically by direct
employment than contracting.

* Adequacy of the contractual agreement for the service . . .

Two issues are presented for our consideration: (1) was the
consultant service reasonable and necessary to the performance of the
award? (2) was the daily rate of reimbursement reasonable?

Whether Obtaining Consulting Services Was Reasonable And Necessary

OMB Circular A-122, "Cost Principles for Non-Profit Organizations,"
at Attachment A, A.2.a provides that to be allowable a cost must be
reasonable for the performance of the grant award. Two of the factors
used to determine the reasonableness of a cost are whether the cost is
of a type generally recognized as ordinary and necessary for the
performance of the award (Attachment A, A.3.a) and whether the
individuals concerned acted with prudence under the circumstances
(Attachment A, A.3.c).

The Agency contended that Grantee had hired an experienced and
qualified person to be the new executive director, the former associate
executive director, who had exercised significant managerial
responsibilities dating back to 1979. Additionally, the Agency's
Regional Office had held training sessions to discuss review system
changes and was available to advise Grantee with regard to the
modification of Grantee's review system. Given the resources available
to Grantee in the form of an experienced new executive director and the
potential for guidance from the Regional Office, the Agency concluded
that the consultant services were unnecessary and unreasonable.

(4) The Agency noted that there was "hardly any documentation to show
why or what the consultant did to benefit" the grant. The Agency, in
essence, regarded the documentation which Grantee did present as
unpersuasive since it been prepared after-the-fact. /1/


Grantee maintained that, given the circumstances, it had exercised
prudent judgment in entering into this contract. Grantee stated that
besides the change in its review system and executive director it faced
a 40% budget cut that necessitated that the position of associate
executive director not be filled. Grantee pointed out that the new
executive director had not, in acting on behalf of the former executive
director during absences since 1979, acquired the same wide-ranging
technical expertise as the former executive director. Grantee pointed
out that its executive director and associate executive director
positions had a functional division of responsibilities. /2/
Additionally, Grantee asserted that during this transition period it was
important for it to show a continuity of administration of the
organization. Grantee stated that engaging the former executive
director as a consultant was the best way to ensure a smooth transition
in such a chaotic time. Grantee argued that its president entered into
the contract for consulting services in the ordinary course of business,
pointing to Article Five, Section 5.5 of its by-laws which provided, in
part, that the president shall have the general powers and duties of
management usually vested in the president of a corporation.
Additionally, Grantee asserted that the president approached the former
executive director (not the converse) to request the consultant services
and the other members of the Board of Trustees concurred in the
arrangement.


(5) In August of 1982, once the Agency auditors had inquired about
this cost, the new executive director prepared a memorandum describing
the consulting services as well as a letter to the Agency auditors that
presented an "aggregate time sheet" prepared from the business calendars
kept by the two executive directors. The "redeveloped time sheets"
showed 75 hours of consulting time and listed the date, approximate
starting and ending time of each instance of consultant services, as
well as the total time and a description of performed activities. The
descriptions included such activities as "assessment of review system,"
"conference-implications on data system of modified review system," and
"(final) preparation for Board presentation." Appellant's June 11, 1984
submission, Attachments (Atts.) C and D.

The new executive director's memorandum stated in part:

This arrangement was agreed to verbally prior to my being hired as
Executive Director and (was) finalized in a letter of agreement.
Because of the existence of the arrangement, I felt comfortable in
liberally calling on (the former executive director) as a resource on
issues related to changes in the review program. The modified review
program affected the hospital review staff; the PSRO's staffing; our
data system and committee structure; and on medical staff's impressions
of the PSRO program.

* * *

. . . In addition, when I was hired on September 1, 1981, although
it was a twelve month contract, there was a three month evaluation
period built in. During that time, I was "on probation", e.g. hired at
a lower salary than which would be implemented if I successfully
completed the three month period; and subject to an evaluation at the
end of the three months.

We find that Grantee could reasonably conclude that it was in a
difficult position at the time it obtained the consulting services.
Although the associate executive director was becoming executive
director, the vacant associate's position would not be filled and the
first three months was a probationary time for the new executive
director. Thus, Grantee was losing one of its top two executives,
without replacement, at a time when it was (6) coming under servere
budget restraints and modifying its review system. Although Grantee
could have sought guidance from the Agency's Regional Office with regard
to the review system modifications, the record shows that the consultant
employed in this instance was readily available to Grantee, familiar
with the intricacies of Grantee's operation, and, arguably, therefore,
more useful. Grantee pointed out that the training available from the
Agency's Regional Office would be designed for instituting nation-wide
review system changes, not an organization's internally administered
review system which operates under a particular set of circumstances.

Furthermore, although the Agency characterized this cost as "unusual"
and asserted that OMB Circular A-122, Attachment A, A.6 instructed
Grantee to seek an advance agreement on unusual costs, that section does
not require Grantee obtain an advance written agreement or to get prior
approval from the Agency and, in fact, states that, "(the) absence of an
advance agreement . . . will not, in itself, affect the reasonableness .
. . of that element." The section states "it is often desirable to seek
a written agreement."

Additionally, there is no basis for concluding that the consultant
services were not adequately supported merely because Grantee's
explanation and description were provided after-the-fact. Although an
explanation presented by Grantee at the time the services were provided
would have had more credibility than an after-the-fact justification,
after-the-fact documentation is not per se insufficient to show that
costs incurred were reasonable and necessary.

The auditors questioned the cost on various grounds, as stated above,
and instructed the Agency that:

Although no single factor or any special combination of factors is
determinative for the allowability of consultant costs, the
aforementioned considerations should be reviewed and documented to
ensure that the services are necessary and reasonable.

Audit Report

Appendix 1, Page 2.

The Agency proceeded to disallow based on the availability of
training sessions and technical assistance from the Regional Office and
the experience of the new executive director. Although these are
grounds for initially (7) questioning the cost -- in the face of the
explanation of the circumstances and the rationale for obtaining the
services that was provided by Grantee -- these grounds do not support
upholding the disallowance. We find that the record shows that Grantee
took prudent and reasonable action to assure that its own management
transition did not adversely affect its simultaneous implementation of
the review system changes. To uphold the disallowance on the grounds
advanced by the Agency would be merely permitting the Agency to second
guess Grantee, the party charged with the responsibility for making the
management and other decisions necessary to run that PSRO program.
Accordingly, we reverse the Agency's determination that the costs were
unreasonable and unnecessary.

Whether The Daily Reimbursement Rate Was Reasonable

The Agency argued that, even if the Board found the consultant
service to be necessary and reasonable to the performance of the grant,
the reimbursement rate of $500 per day was unreasonable. The Agency
stated that a daily rate of $500 was 330% in excess of the consultant's
immediate past salary as executive director. /3/


Grantee argued that since the former executive director was no longer
its employee, the $500 per day fee was necessary to obtain his services.
Grantee argued that the fee was not out of line with other consulting
fees that Grantee had paid, and in essence, that Grantee was obliged to
pay what the consultant charged in order to obtain the services.

Grantee produced invoices for fees paid to other consultants, but
none for the consultant whose fees are the subject of this appeal. The
invoices provided by Grantee were for date processing services,
programming services, a one-day seminar, and two invoices that do not
mention the service provided. Grantee did not draw any connection as to
how these services related to the consultant services provided by the
former executive director or on what basis (8) fees for these dissimilar
services would indicate a reasonable rate of reimbursement for
consultant services performed by Grantee's former executive director.
/4/


Grantee admitted that it never considered anyone for the consultant
position other than the former executive director. Additionally,
Grantee did not submit any evidence of what similar organizations in
Grantee's geographic area paid consultants for similar services or what
this consultant charged others. Therefore, Grantee did not show than an
individual exercising prudent judgment would have paid a $500 per day
rate for these consultant services. The extent to which a cost was
incurred as the result of arms length bargaining is one of the factors
used to determine the reasonableness of a cost. See Circular A-122, A.
3.b. The Agency alleged that because the contract had been arranged
only between the former executive director and Grantee's president, the
contract was not an arms length transaction. /5/


In Oregon Research Institute Inc., Decision No. 34, March 9, 1977,
the Board found that the value of services for which retainer payments
were made "should not automatically be limited to what other
organizations pay regular employees for performing similar services."
However, in this appeal there is nothing in the record to indicate that
these services actually had a value in excess of the salary previously
paid to the former executive director.

OMB Circular A-122 states that a cost is reasonable if in its amount
it does not exceed that which would be incurred by a prudent person
under the circumstances prevailing at (9) the time was made to incur the
cost. We find that Grantee has not shown that a prudent person would
have paid this consultant at a rate of $500 per day.

Grantee has been entrusted with the administration of federal funds
and has an obligation to show that the cost of the consultant services
was reasonable. It cannot contract with its former executive director
for services at a rate of reimbursement arguably far in excess of his
salary without providing evidence of some concrete basis to establish
the rate paid.

Since Grantee has not shown an objective basis for concluding that
the rate paid was reasonable, we find that the consulting fee is
allowable only to the extent of the per hour equivalent rate of the
former Executive Director's salary. Furthermore, we find, as discussed
above, that 75 hours were justified. In addition, the Agency should
consider whether to allow reasonable expenses incurred by the consultant
in performing the services, to the extent that Grantee can document
those expenses. Therefore, we remand this appeal to the Agency (1) to
calculate the allowable charge for the consultant services in accordance
with the forgoing discussion, and (2) to consider Grantee's
documentation if any, with regard to the consultant's expenses. If
Grantee disagrees with the Agency's calculation of the proper per hour
fee or the amount of the consultant's expenses allowed, it may appeal
the Agency's determination to the Board on these narrow issues.

Conclusion

For the reasons stated above, we reverse the Agency's determination
that the consultant costs were unreasonable and unnecessary, uphold the
determination that the amount was unreasonable, and remand to the Agency
for calculation of the amount which should be reimbursed. /1/ During
the telephone conference, we discussed whether the Agency simply
questioned the sufficiency of the supporting documentation or whether we
needed further factual development in order to show that the consulting
services were actually provided. Neither the audit report nor the
record in general supports a conclusion that the services described were
not provided so that we did not pursue the latter point concerning
further factual development. /2/ During the telephone conference
call, Grantee's counsel stated that the new executive director had no
experience with budget matters or program meetings. /3/ The
Agency asserted, without contradiction by Grantee, that the former
executive director's annualized, full-time equivalent salary was
approximately $40,000. /4/ These documents were provided in
response to specific questions from the Board during the conference
call. Grantee's counsel characterized the documents as
"self-explanatory" and offered to provide further information if
required. We did not request further information since we had
explicitly discussed the need to establish the amount paid as reasonable
during the conference call and had provided Grantee with the opportunity
to supplement the record on this point. /5/ The Agency also
argued the lack of "arms length bargaining" as general grounds for
finding that the $5,000 for consultant services was unallowable. Under
the facts here we do not agree that this factor is a basis for
disallowing the entire amount.

MARCH 19, 1985