Luna Innovations, Inc.
ASBCA No. 60086
| A.S.B.C.A. | Nov 29, 2017Background
- Luna Innovations, a publicly traded Virginia corporation, issued employee stock options during FY 2007 and included $2,291,790 of Black‑Scholes–valued option expense in its FY2007 G&A indirect cost submission.
- After its June 2006 IPO, Luna was required by FAS 123R to record fair‑value compensation expense at grant date; Luna used the European Black‑Scholes model with volatility taken from an index of comparable firms.
- DCAA audited Luna's FY2007 incurred cost submission and questioned the stock‑option expense under FAR 31.205‑6(i), which disallows compensation "calculated, or valued, based on changes in the price of corporate securities."
- The contracting officer disallowed the $2,291,790 and assessed penalties under FAR 52.242‑3, demanding $1,141,421 (including interest and adjustments); Luna timely appealed to the ASBCA (ASBCA No. 60086).
- The central factual points: options had strike = market price at grant, 10‑year term with vesting, Black‑Scholes inputs included volatility (from peers), and Luna amortized the grant expense over vesting.
Issues
| Issue | Plaintiff's Argument (Luna) | Defendant's Argument (Government) | Held |
|---|---|---|---|
| Whether Black‑Scholes–valued employee stock option expense is unallowable under FAR 31.205‑6(i) | Black‑Scholes uses multiple inputs; volatility is only one of five variables and thus costs are not "based on" changes in stock price; FAR 31.205‑6(d) permits compensation in corporate securities | Black‑Scholes expressly uses share‑price volatility (a measure of price changes) as a core input, so the valuation is "calculated, or valued, based on changes in the price of corporate securities" and is unallowable | Held unallowable: Black‑Scholes valuation depends on price volatility and so falls within FAR 31.205‑6(i) |
| Whether the costs were "expressly unallowable" (triggering penalties) | The Black‑Scholes valuation is complex, a question of first impression, there was reasonable disagreement within DCAA/DCMA, and Black‑Scholes is an accepted accounting method referenced in FAS 123R | FAR 31.205‑6(i) specifically names compensation valued on securities‑price changes; earlier ASBCA holdings treated TSR‑based schemes as expressly unallowable | Held not expressly unallowable: under an objective standard, given complexity and reasonable differences of opinion, it was not unreasonable for Luna to treat the costs as allowable; penalties reversed |
| Whether penalties (or waiver of penalties) should be applied | Even if costs unallowable, penalties inappropriate because costs not expressly unallowable and circumstances warranted no penalty | Contracting officer assessed penalties under FAR 52.242‑3 because costs were expressly unallowable and had been reimbursed | Court did not reach waiver issue because it found costs not expressly unallowable, so penalties were not sustained |
Key Cases Cited
- LSI Computer Sys., Inc. v. Int'l Trade Comm'n, 832 F.2d 588 (Fed. Cir. 1987) (interpretation of regulatory text looks to plain meaning of words)
- Rumsfeld v. Gen. Dynamics Corp., 365 F.3d 1380 (Fed. Cir. 2004) (discusses the objective "expressly unallowable" standard and reasonable‑person inquiry)