B-218764, DEC 9, 1985

B-218764: Dec 9, 1985

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COMMITTEE ON GOVERNMENTAL AFFAIRS UNITED STATES SENATE THIS IS IN RESPONSE TO YOUR REQUEST FOR COMMENTS ON S. 940. IS INTENDED TO HELP RESTORE INTEGRITY TO THE DOD PROCUREMENT PROCESS BY (1) PROVIDING MORE TOOLS FOR THE DEPARTMENT OF DEFENSE (DOD) TO USE IN ITS EFFORTS TO RECOVER OVERCHARGES AND UNEARNED PROFITS BY DOD CONTRACTORS. OUR COMMENTS ON EACH OF THE TILES ARE ADDRESSED BELOW. TITLE I - UNALLOWABLE CONTRACT COSTS - COST AND PRICING DATA THE OBJECTIVE OF TITLE I IS TO STRENGTHEN THE TRUTH-IN-NEGOTIATIONS ACT BY (1) CLOSING CERTAIN LOOPHOLES WHICH HAVE MADE IT DIFFICULT FOR DOD TO COLLECT OVERCHARGES RESULTING FROM DEFECTIVE PRICING AND (2) ADDING INCENTIVES TO ENCOURAGE CONTRACTORS TO SETTLE DEFECTIVE PRICING CASES AS SOON AS POSSIBLE.

B-218764, DEC 9, 1985

PRECIS-UNAVAILABLE

THE HONORABLE WILLIAM V. ROTH:

CHAIRMAN, COMMITTEE ON GOVERNMENTAL AFFAIRS

UNITED STATES SENATE

THIS IS IN RESPONSE TO YOUR REQUEST FOR COMMENTS ON S. 940, ENTITLED THE DEFENSE PROCUREMENT PROGRAM INTEGRITY ACT OF 1985. THIS BILL, WHICH YOU INTRODUCED ON APRIL 17, 1985, IS INTENDED TO HELP RESTORE INTEGRITY TO THE DOD PROCUREMENT PROCESS BY (1) PROVIDING MORE TOOLS FOR THE DEPARTMENT OF DEFENSE (DOD) TO USE IN ITS EFFORTS TO RECOVER OVERCHARGES AND UNEARNED PROFITS BY DOD CONTRACTORS, (2) REQUIRING MORE INFORMATION ON PROFITS IN THE DOD INDUSTRY, AND (3) ENSURING THE EFFECTIVENESS OF THE COST ACCOUNTING STANDARDS, AMONG OTHER THINGS.

WE SUPPORT THE INTENT OF THE BILL AND THE NEED TO IMPROVE THE DOD PROCUREMENT PROCESS. THE BILL HAS FIVE TITLES, EACH ADDRESSING SEPARATE ASPECTS OF THE DEFENSE PROCUREMENT PROCESS. OUR COMMENTS ON EACH OF THE TILES ARE ADDRESSED BELOW.

TITLE I - UNALLOWABLE CONTRACT

COSTS - COST AND PRICING DATA

THE OBJECTIVE OF TITLE I IS TO STRENGTHEN THE TRUTH-IN-NEGOTIATIONS ACT BY (1) CLOSING CERTAIN LOOPHOLES WHICH HAVE MADE IT DIFFICULT FOR DOD TO COLLECT OVERCHARGES RESULTING FROM DEFECTIVE PRICING AND (2) ADDING INCENTIVES TO ENCOURAGE CONTRACTORS TO SETTLE DEFECTIVE PRICING CASES AS SOON AS POSSIBLE. TITLE I PROPOSES FOUR BASIC CHANGES TO EXISTING LAW.

THE FIRST WOULD ADD AN ADDITIONAL REQUIREMENT TO THE CERTIFICATION OF COST OR PRICING DATA WHICH CONTRACTORS ARE REQUIRED TO MAKE TO THE GOVERNMENT. THE SECOND CHANGE PROHIBITS AS DEFENSES IN AN ADMINISTRATIVE OR JUDICIAL PROCEEDING TO ADJUST THE PRICE OF A CONTRACT, EIGHT SPECIFIC ARGUMENTS CONTRACTORS MIGHT MAKE FOR WHY INACCURATE OR INCOMPLETE COST AND PRICING DATA SHOULD NOT RESULT IN AN ADJUSTMENT TO THE CONTRACT PRICE. THE THIRD CHANGE REQUIRES THAT INTEREST BE APPLIED TO OVERPAYMENTS RESULTING FROM DEFECTIVE PRICING. THE FINAL CHANGE WOULD PREVENT THE USE OF OFFSETS BY RESTRICTING THE DEFECTIVE DATA THAT MAY BE CONSIDERED IN AN ADMINISTRATIVE OR JUDICIAL PROCEEDING TO REDUCE THE CONTRACT PRICE AS A RESULT OF DEFECTIVE PRICING.

FIRST, THE BILL WOULD AMEND THE CERTIFICATION REQUIREMENT IN 10 U.S.C. SEC. 2306(F) BY REQUIRING CONTRACTORS TO ALSO CERTIFY THAT THE COSTS ARE ALLOWABLE IN ACCORDANCE WITH REQUIREMENTS OF LAW AND APPLICABLE REGULATIONS. THE EXISTING LAW ONLY REQUIRES THAT THE COST AND PRICING DATA BE CERTIFIED AS ACCURATE, COMPLETE, AND CURRENT. WE SUPPORT THIS CHANGE BECAUSE IT SHOULD INCREASE CONTRACTOR ACCOUNTABILITY FOR DETERMINING WHAT COSTS ARE AND ARE NOT ALLOWABLE. DOD RECENTLY INSTITUTED A SIMILAR CHANGE IN THEIR REGULATIONS WHICH REQUIRES CONTRACTORS TO CERTIFY THAT THEIR BILLINGS DO NOT INCLUDE UNALLOWABLE COSTS.

HOWEVER, BECAUSE CONTRACTORS CERTIFY "TO THE BEST OF THEIR KNOWLEDGE AND BELIEF," THE BENEFITS OF REQUIRING CERTIFICATION THAT COSTS ARE ALLOWABLE UNDER LAW MAY BE NEGATED IF THERE IS NOT CLEAR AND PRECISE GUIDANCE ON WHAT COSTS ARE AND ARE NOT ALLOWABLE. WITHOUT SUCH GUIDANCE, CONTRACTORS MAY ARGUE THAT IN SOME CIRCUMSTANCES THEY ARE CERTIFYING TO A POTENTIAL UNCERTAINTY. THIS MAY LEAD TO CONTRACTORS SUCCESSFULLY CONTENDING THAT ALTHOUGH SOME COSTS WERE UNALLOWABLE, THE CERTIFICATION WAS NOT IMPROPER BECAUSE THE RELEVANT GUIDANCE WAS UNCLEAR AND THE CONTRACTOR HAD TO RELY ON HIS "BELIEF." IN RECENT REPORTS WE RECOMMENDED THAT DOD TAKE STEPS TO MORE CLEARLY DEFINE THOSE COSTS WHICH ARE UNALLOWABLE.

COST ACCOUNTING STANDARD 405 (CAS 405), ACCOUNTING FOR UNALLOWABLE COSTS, WAS PROMULGATED TO FACILITATE THE NEGOTIATION, AUDIT, ADMINISTRATION, AND SETTLEMENT OF CONTRACTS BY ESTABLISHING GUIDELINES COVERING: (1) THE IDENTIFICATION OF COSTS SPECIFICALLY DESCRIBED IN THE FEDERAL ACQUISITION REGULATIONS AS UNALLOWABLE AND (2) THE ACCOUNTING TREATMENT TO BE ACCORDED SUCH COSTS. ACCORDING TO THE CAS 405, COSTS EXPRESSLY UNALLOWABLE OR MUTUALLY AGREED TO BE UNALLOWABLE ARE TO BE IDENTIFIED AND EXCLUDED FROM ANY BILLING, CLAIM, OR PROPOSAL APPLICABLE TO A GOVERNMENT CONTRACT. BEING MORE SPECIFIC REGARDING WHAT COSTS ARE EXPRESSLY UNALLOWABLE UNDER CAS 405 WILL HELP REMOVE THE PRESENT AMBIGUITY IN THE PROCUREMENT REGULATIONS AND IMPROVE THE LIKELIHOOD THAT CONTRACTORS WILL COMPLY WITH THE INTENT OF THE PROPOSED LEGISLATION. ON MAY 18, 1985, DOD ISSUED 33 ACQUISITION INITIATIVES, SOME OF WHICH ADDRESS THE PROBLEM OF UNALLOWABLE COSTS. THESE INITIATIVES ARE CURRENTLY BEING ACTIVELY CONSIDERED BY DOD FOR IMPLEMENTATION.

SECOND THE BILL WOULD AMEND 10 U.S.C. SEC. 2306 BY ADDING SUBSECTION (I)(2) AND (3). IN ANY ADMINISTRATIVE OR JUDICIAL PROCEEDING TO ADJUST THE PRICE OF A CONTRACT BECAUSE THE CONTRACTOR PROVIDED INACCURATE, INCOMPLETE, OR NONCURRENT COST OR PRICING DATA, NEW SUBSECTION 2306 (I)(2) WOULD CREATE A CONCLUSIVE PRESUMPTION THAT THE GOVERNMENT RELIED ON THE DATA FURNISHED BY THE CONTRACTOR. NEW SUBSECTION 2306 (I)(3) PROHIBITS AS A DEFENSE EIGHT DIFFERENT ARGUMENTS A CONTRACTOR MIGHT MAKE AS TO WHY THE DEFECTIVE COST AND PRICING DATA SHOULD NOT RESULT IN ADJUSTING THE CONTRACT PRICE.

IN INTRODUCING S. 940, YOU EXPRESSED YOUR BELIEF THAT RECENT DECISIONS BY THE ARMED SERVICES BOARD OF CONTRACT APPEALS (ASBCA) HAVE WEAKENED THE LAW WHICH ALLOWS THE GOVERNMENT TO RECOVER OVERPAYMENTS RESULTING FROM DEFECTIVE COST AND PRICING DATA. SPECIFICALLY, YOU REFERRED TO CASES IN WHICH THE ASBCA RULED FOR CONTRACTORS WHO ARGUED THAT THE CONTRACT PRICE SHOULD NOT BE REDUCED BECAUSE (1) THE GOVERNMENT SHOULD HAVE KNOWN THAT SOME INFORMATION AVAILABLE TO THE CONTRACTOR WAS NOT DISCLOSED, (2) THE DATA WAS GIVEN TO A GOVERNMENT EMPLOYEE ALTHOUGH NOT TO THE CONTRACTING OFFICER, (3) THE PROCUREMENT WAS SOLE SOURCE, AND (4) THE CONTRACTOR WAS IN A SUPERIOR BARGAINING POSITION. NEW SUBSECTION 2306 (I)(3) WOULD PROHIBIT AS DEFENSES THE FOUR ARGUMENTS DESCRIBED ABOVE, AMONG OTHERS.

WE REVIEWED THE APRIL 14, 1983, HEARINGS /1/ ON DEFECTIVE PRICING. THE HEARINGS PROVIDE MANY EXAMPLES OF ASBCA DECISIONS IN WHICH THE CONTRACTOR DID NOT PROVIDE COST AND PRICING DATA OR PROVIDED DATA THAT WAS INACCURATE, INCOMPLETE, OR NONCURRENT, BUT THE ASBCA DENIED THE ADJUSTMENT TO THE CONTRACT PRICE SOUGHT BY THE GOVERNMENT. THE HEARINGS REFLECT SOME DISAGREEMENT OVER THE BASIS OF THESE DECISIONS.

IN VIEW IS THAT RECENT ASBCA DECISIONS HAVE CREATED DEFENSES NOT FOUND IN THE STATUTE OR ITS LEGISLATIVE HISTORY WHICH, IN EFFECT, FORCE THE GOVERNMENT TO RECONSTRUCT THE ORIGINAL NEGOTIATIONS IN DETAIL TO SHOW HARM TO THE GOVERNMENT. /2/ THESE DECISIONS ARE CONTRARY TO THE NATURAL AND PROBABLE CONSEQUENCES PRESUMPTION, ADOPTED IN EARLIER DECISIONS, THAT THERE IS A DOLLAR-FOR-DOLLAR REDUCTION IN THE CONTRACT PRICE EQUAL TO THE AMOUNT OF THE DEFECTIVE PRICING. /3/ CONSEQUENTLY, WHILE THE PRESUMPTION REMAINS A RULE TO BE APPLIED IN CERTAIN CASES, THE DEFENSES ALLOWED IN THE MORE RECENT ASBCA DECISIONS RESULT IN PLACING SEVERE AND RESTRICTIVE EVIDENTIARY BURDENS UPON THE GOVERNMENT. /4/

A CONTRARY VIEW PRESENTED IN THE HEARINGS IS THAT THE PRESUMPTION REMAINS IN FORCE, BUT MOST CASES NECESSARILY ARE DECIDED ON THE FACTS OF THE CASE AND NOT ON SOME GENERAL PRINCIPLE. THEREFORE, WHEN THE CONTRACTOR OVERCOMES THE PRESUMPTION, THE GOVERNMENT MUST PROVE THAT THE DEFECTIVE DATA RESULTED IN AN OVERSTATEMENT OF THE CONTRACT PRICE. THE WEAKNESSES IN CASES THE GOVERNMENT HAS LOST REFLECTED A LACK OF UNDERSTANDING OF THE FACTS NEEDED TO PRESENT AN EFFECTIVE PRICING CASE. /5/ IN MOST OF THE CASES DISCUSSED IN THE HEARING, THE ACCUMULATIVE EFFECT OF THE EVIDENCE PRESENTED FAILED TO SHOW THAT THE CONTRACT PRICE WAS OVERSTATED BY DEFECTIVE PRICING. /6/

WE HAVE NOT REVIEWED THE UNIVERSE OF ASBCA DECISIONS TO DETERMINE HOW FREQUENTLY THE DEFENSES PROHIBITED BY THE ACT HAVE BEEN USED. IT IS OF COURSE DIFFICULT TO DETERMINE WHETHER A PARTICULAR CASE WAS CORRECTLY DECIDED WITHOUT BEING PRIVY TO ALL THE TESTIMONY AND INFORMATION PRESENTED BY THE GOVERNMENT AND THE CONTRACTOR. FURTHER, THE DIFFERENT VIEWS EXPRESSED AT THE HEARINGS SUGGEST THAT THE RATIONALES FOR THE DECISIONS ARE SUBJECT TO MORE THAN ONE REASONABLE INTERPRETATION. NEVERTHELESS, WE SHARE YOUR CONCERN THAT THE GOVERNMENT BE ABLE TO RECOVER OVERPAYMENTS ATTRIBUTABLE TO CONTRACTORS NOT FURNISHING ACCURATE, COMPLETE, AND CURRENT COST AND PRICING DATA. WE ENDORSE THE INTENT OF YOUR PROPOSAL TO THE EXTENT IT REPRESENTS A LEGISLATIVE RESPONSE TO JUDICIAL AND ADMINISTRATIVE DECISIONS, WHICH THE CONGRESS BELIEVES ARE INCONSISTENT WITH THE PURPOSE OF THE TRUTH-IN NEGOTIATIONS ACT.

HOWEVER, WE ARE CONCERNED ABOUT SOME ISSUES PRESENTED BY THE SPECIFIC SOLUTIONS CONTAINED IN PROPOSED SUBSECTIONS (I)(2) AND (3). BY CREATING A CONCLUSIVE PRESUMPTION THAT THE GOVERNMENT RELIED ON THE DATA FURNISHED, SUBSECTIONS (I)(2) AND (3) APPEAR TO PROHIBIT, OR AT LEAST LIMIT, CONSIDERATION OF WHETHER DEFECTIVE DATA, IN FACT, CONTRIBUTED TO THE NEGOTIATION OF AN INFLATED CONTRACT PRICE. A PURPOSE OF S. 940 IS TO ENABLE THE GOVERNMENT TO RECOVER OVERCHARGES RESULTING FROM DEFECTIVE DATA. HOWEVER, RESTRICTING CONSIDERATION OF THE RELATIONSHIP BETWEEN THE DEFECTIVE DATA AND AN ALLEGED OVERCHARGE MAY NOT BE ENTIRELY CONSISTENT WITH THAT PURPOSE, IN SOME CASES. ALSO, THE SPECIFIC PROHIBITION OF EIGHT DEFENSES SUGGESTS THAT OTHER DEFENSES MAY BE AVAILABLE. YET, IT IS UNCLEAR TO WHAT EXTENT SUCH OTHER DEFENSES WOULD BE ENTERTAINED IN LIGHT OF THE CONCLUSIVE PRESUMPTION CREATED.

TO ADDRESS THESE CONCERNS, YOU MAY WISH TO CONSIDER AN ALTERNATIVE. SUBSECTION (I)(2) COULD BE REVISED TO PROVIDE FOR REBUTTABLE PRESUMPTIONS THAT THE GOVERNMENT RELIED ON ALL COST AND PRICING DATA RECEIVED FROM THE CONTRACTOR, AND THAT THE NATURAL AND PROBABLE CONSEQUENCE OF DEFECTIVE DATA IS A DOLLAR-FOR-DOLLAR REDUCTION IN THE CONTRACT PRICE EQUAL TO THE AMOUNT OF THE DEFECTIVE PRICING. THIS WOULD CODIFY INTO LAW THE PRESUMPTIONS WHICH HAVE BEEN VIEWED AS ESSENTIAL TO EFFECTIVE ENFORCEMENT. RATHER THAN PROHIBITING SPECIFIC DEFENSES, SUBSECTION (I)(3) THEN COULD BE REVISED TO PROVIDE THAT THE CONTRACTOR CAN REBUT THE PRESUMPTIONS ONLY BY PROVING, BY AN APPROPRIATE STANDARD OF EVIDENCE, THAT THE DEFECTIVE COST AND PRICING DATA DID NOT AFFECT THE PRICE OF THE CONTRACT. TAKEN TOGETHER, THE REVISIONS WOULD CLEARLY PLACE THE BURDEN OF PROOF ON THE CONTRACTOR WHO DID NOT FURNISH ACCURATE, COMPLETE, AND CURRENT COST AND PRICING DATA. SUCH A STATUTORY SCHEME SHOULD MAKE IT MORE DIFFICULT FOR CONTRACTORS TO AVOID A REDUCTION IN THE CONTRACT PRICE FOR DEFECTIVE PRICING, WITHOUT ALSO RESTRICTING JUDICIAL AND ASBCA CONSIDERATION OF THE RELATIONSHIP BETWEEN THE DEFECTIVE DATA AND THE ALLEGED OVERCHARGE.

THIRD THE PROPOSED BILL WOULD ADD SUBSECTIONS (J)(1) AND (2) TO 10 U.S.C. SEC. 2306, AND REQUIRE INTEREST ON THE OVERPAYMENTS IN CASES WHERE DEFECTIVE PRICING HAS BEEN ESTABLISHED. CONTRACTORS WOULD BE REQUIRED TO REPAY THE AMOUNT OF THE OVERCHARGE ALONG WITH INTEREST CHARGED FROM THE DATE THE OVERPAYMENT OCCURED UNTIL IT IS REPAID. YOUR BILL SPECIFIES THAT THE INTEREST RATE SHALL BE THE SAME RATE AS THAT USED BY THE INTERNAL REVENUE SERVICE FOR UNDERPAYMENT OF TAXES. CURRENT INTERNAL REVENUE SERVICE PROVISIONS REQUIRE A SEMIANNUAL ADJUSTMENT TO REFLECT CHANGES IN THE PRIME LENDING RATE. WE BELIEVE ADDING INTEREST MORE ACCURATELY REPRESENTS THE PRESENT VALUE OF THE PAST OVERPAYMENT TO THE CONTRACTOR BY THE GOVERNMENT. WE SUPPORT THIS CHANGE SINCE IT REMOVES WHAT MAY BE AN INCENTIVE FOR CONTRACTORS TO DELAY SETTLEMENT OF DEFECTIVE PRICING CASES.

FOURTH THE BILL WOULD ADD SUBSECTION (I)(1) TO 10 U.S.C. SEC. 2306, AND RESTRICT THE CONSIDERATION OF DEFECTIVE COST AND PRICING DATA TO DATA SHOWING HIGHER COSTS THAN THE ACCURATE DATA WHICH SHOULD HAVE BEEN FURNISHED. THIS CHANGE WOULD PREVENT THE USE OF OFFSETS TO REDUCE THE CONTRACTOR'S LIABILITY FOR DEFECTIVE PRICING THAT INCREASES THE CONTRACT PRICE. AN OFFSET OCCURS WHEN A CONTRACTOR IS PERMITTED TO DEMONSTRATE THAT A DECREASE IN THE CONTRACT PRICE RESULTED FROM OTHER DEFECTIVE DATA SUBMITTED BY THE CONTRACTOR. UNDER PRESENT CASE LAW, A CONTRACTOR WHO SUBMITS DEFECTIVE DATA RESULTING IN AN OVERPAYMENT BY THE GOVERNMENT CAN PRESENT EVIDENCE TO SHOW THAT THE GOVERNMENT ALSO RELIED ON OTHER DEFECTIVE DATA WHICH RESULTED IN AN UNDERPAYMENT. IF SUCCESSFUL, A CONTRACTOR IS PERMITTED TO REDUCE THE AMOUNT OF THE OVERPAYMENT BY THE AMOUNT OF AN UNDERPAYMENT. AFTER PASSAGE OF THE TRUTH-IN-NEGOTIATIONS ACT IN 1962 (PUBLIC LAW 87-653), DOD INTERPRETED THE ACT AS NOT PERMITTING OFFSETS. ASBCA SUSTAINED DOD'S INTERPRETATION OF PUB.L. NO. 87-653, HOLDING THAT THE STATUTE PROVIDED A REMEDY FOR DEFECTIVE PRICING ONLY TO THE GOVERNMENT. IN 1969 THE COURT OF CLAIMS REVERSED THE ASBCA'S RULING OF NOT PERMITTING OFFSETS. THE CHANGE WOULD OVERTURN THE EFFECT OF THE COURT OF CLAIMS DECISION AND REINSTATE THE PROHIBITION AGAINST OFFSETS IN FUTURE CASES.

WE SUPPORT YOUR PROPOSAL TO ELIMINATE OFFSETS. ONE PURPOSE OF REQUIRING CONTRACTORS TO SUBMIT COST AND PRICING DATA WAS TO PROVIDE THE GOVERNMENT WITH THE INFORMATION NEEDED TO NEGOTIATE ON AN EQUAL FOOTING. THE REMEDY PROVIDED TO THE GOVERNMENT TO REDUCE THE CONTRACT PRICE WAS INTENDED TO COMPENSATE IT FOR PRICE INCREASES RESULTING FROM INACCURATE, INCOMPLETE, OR NONCURRENT INFORMATION SUBMITTED BY THE CONTRACTOR. THE USE OF OFFSETS IS INCONSISTENT WITH THESE PURPOSES BECAUSE THEY ALLOW CONTRACTORS TO OBTAIN A REMEDY, AND THEREBY ESCAPE THE FULL CONSEQUENCES, FOR FAILING TO COMPLY WITH THE STATUTORY REQUIREMENT TO PROVIDE ACCURATE COST AND PRICING DATA. FURTHER WHEN CONTRACTORS CLAIM OFFSETS, GOVERNMENT PERSONNEL MUST EXPEND CONSIDERABLE RESOURCES TO AUDIT THE VALIDITY OF THE CLAIM. FINALLY, THE DETERRENT FOR NOT PROVIDING ACCURATE, COMPLETE, AND CURRENT DATA, THAT IS, REDUCTION IN THE CONTRACT PRICE, IS REDUCED IF PRICE INCREASES ALSO ARE ALLOWED. TITLE II - RENEGOTIATION ACT

TITLE II WOULD REACTIVATE THE RENEGOTIATION BOARD, WHICH WAS RESPONSIBLE FOR REVIEWING DOD CONTRACTORS' PROFITS IN AN EFFORT TO ENSURE THAT CONTRACTORS DID NOT EARN EXCESSIVE PROFITS ON DEFENSE CONTRACTS. IT WOULD AUTHORIZE A $10 MILLION APPROPRIATION FOR FISCAL YEAR 1986 AND MAKE TECHNICAL ADJUSTMENTS IN THE WAY THE BOARD REVIEWED CONTRACTOR PROFITS.

INDUSTRY HAD BEEN OPPOSED TO THE RENEGOTIATION BOARD, BOTH IN CONCEPT AND OPERATION SINCE ITS INCEPTION. THE BOARD DID NOT RECEIVE AN APPROPRIATION AND THEREFORE CEASED OPERATION IN 1979.

WE SHARE YOUR CONCERNS REGARDING THE ISSUE OF PROFITS ON DOD CONTRACTS AND METHODS BY WHICH THE GOVERNMENT CAN ASSURE ITSELF THAT PROFITS ARE NOT EXCESSIVE. WE HAVE FOR SOME TIME EXPRESSED CONCERN FOR ADEQUATE CONTROLS IN LIGHT OF THE RAPID GROWTH IN DEFENSE SPENDING. AT A TIME WHEN THE DEFENSE PROCUREMENT OUTLAYS HAVE RISEN SO RAPIDLY, WE BELIEVE THAT INDUSTRY AS WELL AS GOVERNMENT NEEDS TO PAY PARTICULAR ATTENTION TO PROFITS AS WELL AS ALL ASPECTS OF THE PROCUREMENT PROCESS TO BE SURE THAT ABUSES DO NOT OCCUR.

BECAUSE OF THE SIGNIFICANT INCREASE IN DEFENSE SPENDING AND CONCERN THAT THIS BUILDUP NOT RESULT IN EXCESSIVE PROFITS, WE AND OTHERS RECOMMENDED THAT DOD MAKE A COMPREHENSIVE REVIEW OF ITS PROFIT POLICY. A STUDY WAS ANNOUNCED BY THE DEPUTY SECRETARY OF DEFENSE IN DECEMBER 1983. THE DEFENSE FINANCIAL AND INVESTMENT REVIEW (DFAIR) WAS RELEASED ON AUGUST 6, 1985. AT YOUR REQUEST, WE ARE REVIEWING THE STUDY AND WILL REPORT TO YOU ON THE RESULTS OF OUR REVIEW.

WE BELIEVE PERIODIC STUDIES SHOULD BE MADE BY DOD TO EVALUATE OVERALL DEFENSE CONTRACT PROFITS. HOWEVER, THE DATA ON WHICH SUCH STUDIES ARE BASED SHOULD NOT BE LIMITED TO DATA SUBMITTED VOLUNTARILY BY CONTRACTORS AS WAS THE CASE WITH PREVIOUS DOD STUDIES, PROFIT '76 IN 1975, AND THE RECENTLY COMPLETED DFAIR STUDY. WE BELIEVE THAT LEGISLATION SHOULD REQUIRE CONTRACTORS TO PROVIDE THE NECESSARY DATA, RATHER THAN BASING THE STUDY ON VOLUNTARY COMPLIANCE. SPECIFIC RECOMMENDATIONS REGARDING PROFIT STUDIES, AS WOULD BE REQUIRED BY TITLE IV OF S. 940, ARE DISCUSSED ON PAGES 8 AND 9 OUR COMMENTS.

WE BELIEVE THAT IF PROFIT STUDIES ARE PROPERLY MADE AND USED BY DOD TO MONITOR PROFITS ON CONTINUING AND TIMELY BASIS, DOD WILL BE ABLE TO MAKE POLICY DECISIONS NECESSARY TO ASSURE THAT PROFITS REMAIN AT REASONABLE LEVELS. WE BELIEVE THAT SUCH A SYSTEM, TOGETHER WITH AGGRESSIVE ENFORCEMENT OF EXISTING LAWS AND THE LEGISLATIVE CHANGES PROPOSED IN S. 940, WOULD BE PREFERABLE TO A RENEGOTIATION BOARD.

TITLE III - COST ACCOUNTING STANDARDS BOARD

TITLE III ADDRESSES A SUBJECT WHICH WE AGREE NEEDS ATTENTION, AND WE CONCUR WITH THE APPROACH IN THE BILL. COST ACCOUNTING STANDARDS ARE CRITICALLY IMPORTANT TO THE GOVERNMENT ACQUISITION PROCESS. IN REVIEWING COMPLIANCE WITH THE STANDARDS PROMULGATED BY THE NOW DEFUNCT COST ACCOUNTING STANDARDS BOARD, WE FOUND THAT THE STANDARDS ARE GENERALLY EFFECTIVE AND THAT FEDERAL DEPARTMENTS' AND AGENCIES' IMPLEMENTATION OF THE STANDARDS HAS BEEN GENERALLY GOOD. HOWEVER, IT HAS BECOME INCREASINGLY DIFFICULT FOR CONTRACTORS, AGENCY OFFICIALS, AND THOSE CHARGED WITH RESOLVING QUESTIONS ASSOCIATED WITH THE COST ACCOUNTING STANDARDS TO CONTINUE OPERATING EFFICIENTLY WITHOUT A MEANS OF ADJUSTING THE STANDARDS TO MEET NEWLY PERCEIVED NEEDS.

TITLE III WOULD REESTABLISH THE BOARD BUT CHANGE THE STATUS OF IT AND ITS MEMBERS. THE BOARD WOULD BE AND INDEPENDENT ESTABLISHMENT IN THE EXECUTIVE BRANCH, AND BOARD MEMBERS WOULD BE APPOINTED BY THE PRESIDENT, WITH ADVICE AND CONSENT OF THE SENATE. TITLE III ALSO PROVIDES FOR A 90- DAY WAITING PERIOD FOR PROMULGATED STANDARDS TO TAKE EFFECT DURING WHICH TIME THERE WOULD BE AN OPPORTUNITY FOR THE CONGRESS TO PASS AND THE PRESIDENT TO SIGN LEGISLATION DISAPPROVING STANDARDS. THIS DIFFERS FROM THE PRIOR LAW WHICH PROVIDED A 60-DAY PERIOD FOR THE CONGRESS TO DISAPPROVE STANDARDS BY PASSING CONCURRENT RESOLUTIONS.

WE HAVE TESTIFIED ON SEVERAL OCCASIONS IN SUPPORT OF REESTABLISHING A COST ACCOUNTING STANDARDS BOARD SUCH AS YOU ARE PROPOSING HERE AND WE SUPPORT TITLE III. WE DO RECOMMEND A CHANGE, HOWEVER, TO SECTION 302(C)(1) OF THE BILL. SECTION 302(C)(1) AMENDS THE PRIOR LAW TO CHANGE THE INTEREST RATE, APPLICABLE TO PRICE ADJUSTMENTS FOR NOT COMPLYING WITH STANDARDS, FROM A MAXIMUM OF 7 PERCENT TO A RATE DETERMINED BY THE SECRETARY OF THE TREASURY BASED ON CURRENT LONG-TERM FEDERAL BORROWING RATES. WE RECOMMEND THE APPLICABLE INTEREST RATE BE THAT ESTABLISHED UNDER SECTION 6621 OF THE INTERNAL REVENUE CODE OF 1954. THIS WOULD BE CONSISTENT WITH THE RATE CONTAINED IN SECTION 101(B) OF THE BILL FOR PRICE ADJUSTMENTS FOR DEFECTIVE PRICING DATA.

TITLE IV - CONTRACTOR PROFIT STUDIES

TITLE IV WOULD REQUIRE THE SECRETARY OF DEFENSE, ON A REGULAR PERIODIC BASIS (AT LEAST ONCE EVERY 4 YEARS), TO CARRY OUT STUDIES OF PROFITS MADE BY CONTRACTORS UNDER DEFENSE CONTRACTS TO DETERMINE WHETHER THE LEVEL OF SUCH PROFITS IS REASONABLE.

AS WE DISCUSSED IN OUR COMMENTS ON TITLE II, WE CONCUR WITH THE NEED TO PERIODICALLY SURVEY THE PROFITS AND FINANCES OF DEFENSE CONTRACTORS. HAVE ADVOCATED PERIODIC STUDIES OF DEFENSE CONTRACT PROFITABILITY FOR SOME TIME. ON NOVEMBER 9, 1984, WE SENT A LETTER TO THE SECRETARY OF DEFENSE CONCERNING THE DFAIR STUDY AND EXPRESSED OUR CONCERN ABOUT THE ACCURACY AND RELIABILITY OF DATA THAT WAS BEING FURNISHED BY CONTRACTORS ON A VOLUNTARY BASIS. WE CAUTIONED ABOUT RELYING ON DATA THAT IS ONLY SELECTIVELY SUBMITTED AS A SATISFACTORY BASIS FOR ANY RELIABLE PROFITABILITY ANALYSIS. ACCORDINGLY, WE SUPPORT THE PURPOSE OF TITLE IV TO STATUTORILY REQUIRE PROFIT STUDIES. IF ENACTED, THE LEGISLATION WOULD HELP ELIMINATE THE INHERENT WEAKNESS OF MAKING LONG-TERM PROFIT DECISIONS BASED ON VOLUNTARY DATA WHICH MAY NOT BE COMPLETE OR ACCURATE.

WE RECOMMEND THAT SPECIFIC REQUIREMENTS REGARDING THE PROFIT STUDY BE INCLUDED IN TITLE IV TO ENSURE THAT THE OBJECTIVES OF THE LEGISLATION ARE ACHIEVED. IT IS UNCLEAR FROM THE PROPOSED LEGISLATION ON WHAT BASIS CONTRACTORS WILL BE SELECTED FOR STUDY, AND SPECIFICALLY WHAT CONTRACTS WILL BE INCLUDED. WE BELIEVE THAT PROFITS OF DEFENSE CONTRACTORS SHOULD BE ANALYZED BY DIVISION OR SEGMENT, DEPENDING ON THE TYPE OR CLASS OF PRODUCT OR PRODUCT LINE THE COMPANY PROVIDES TO DOD. FOR EXAMPLE, IF A COMPANY HAS AIRCRAFT AND SHIPBUILDING DIVISIONS, SEPARATE STUDIES SHOULD BE MADE FOR EACH DIVISION. WE RECOMMEND THE LEGISLATION REQUIRE THAT THE SECRETARY OF DEFENSE PRESCRIBE BY REGULATION THE TYPES OR CLASSES OF PRODUCTS OF PRODUCT LINES FOR WHICH PROFIT STUDIES WOULD BE MADE. TO THE EXTENT PRACTICABLE, WE SUGGEST THAT THE SEGREGATION OF PRODUCT LINES PRESCRIBED IN THE REGULATIONS REFLECT THE IDENTIFICATION OF PRODUCT LINES CONTAINED IN THE FORM 10-K ANNUAL REPORTS WHICH COMPANIES MUST FILE WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO SECTION 13 OF THE SECURITIES EXCHANGE ACT OF 1934, 15 U.S.C. SEC. 78M, AND IMPLEMENTING REGULATIONS.

TO ENSURE THAT THE STUDY FOCUSES ON LARGER DEFENSE CONTRACTORS, YOU MAY WISH TO CONSIDER PROVIDING THAT CONTRACTORS REQUIRED TO FILE A DISCLOSURE STATEMENT BY COST ACCOUNTING STANDARDS BOARD REGULATIONS, CONTAINED IN 4 C.F.R. CHAPTER III, ALSO BE REQUIRED TO PROVIDE TO THE SECRETARY OF DEFENSE THE INFORMATION NEEDED FOR THE PROFIT STUDY. IT ALSO WOULD BE USEFUL TO REQUIRE THAT THE INFORMATION PROVIDED BY THE CONTRACTORS INCLUDE A RECONCILIATION OF THE PROFIT DATA TO THE FINANCIAL STATEMENTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THE RECONCILIATION WOULD PROVIDE A DEGREE OF ASSURANCE THAT THE CONTRACTOR INFORMATION ON WHICH THE STUDY IS BASED IS RELIABLE.

WE ALSO NOTE THAT TITLE IV DOES NOT SPECIFICALLY PROVIDE DOD ACCESS TO CONTRACTOR INFORMATION. WHILE IT IS DOUBTFUL THAT DOD WOULD BE DENIED ACCESS TOTALLY, QUESTIONS MAY ARISE REGARDING ACCESS TO SPECIFIC INFORMATION. TO AVOID ANY CONFUSION, WE RECOMMEND THAT DOD SPECIFICALLY BE PROVIDED ACCESS TO ALL PAPERS, DOCUMENTS, AND RECORDS OF A COMPANY NECESSARY TO MAKE THE PROFIT STUDY. WE ALSO BELIEVE DOD SHOULD BE PROVIDED ACCESS TO THE WORKPAPERS OF ANY CERTIFIED PUBLIC ACCOUNTANT USED BY THE COMPANY IN COLLECTING THE PROFIT DATA AND RECONCILING THE PROFIT DATA TO THE FINANCIAL STATEMENTS.

TITLE V - LIMITATION ON CONTRACTOR CLAIMS

THE PROPOSED LEGISLATION UNDER TITLE V WOULD STATUTORILY LIMIT THE PERIOD OF TIME IN WHICH A CONTRACTOR MAY FILE A CLAIM. THE PROPOSED LIMIT IS 18 MONTHS "AFTER THE DATE OF THE EVENT (OR THE LAST DAY OF THE EVENT, AS THE CASE MAY BE) ON WHICH THE CLAIM IS BASED." IN RESPONSE TO SHIPBUILDING CLAIMS FILED YEARS AFTER THE ACTION GENERATING THE CLAIM OCCURED, LEGISLATION WAS ENACTED LAST YEAR TO LIMIT TO 18 MONTHS, THE STATUTORY PERIOD FOR FILING A CLAIM BY SHIPBUILDING CONTRACTORS AGAINST THE NAVY. NO SIMILAR STATUTORY DEADLINE EXISTS FOR OTHER DOD PROCUREMENTS. THE UNIFORM IMPOSITION OF THE 18-MONTH LIMIT TO ALL DEFENSE CONTRACTORS WOULD HELP ELIMINATE CONFUSION THAT MIGHT ARISE FROM DIFFERENT DOD CONTRACT CLAIMS BEING SUBJECTED TO DIFFERENT STATUTORY TIME FRAMES. IN INTRODUCING THE LEGISLATION, YOU STATED THE 18-MONTH PERIOD, BY EXPEDITING THE CONSIDERATION OF CLAIMS, WILL HELP ENSURE FAIR AND EQUITABLE SETTLEMENTS AND AVOID COSTLY LITIGATION.

WE HAVE NO BASIS FOR COMMENTING ON WHETHER THE 18-MONTH PERIOD STRIKES THE PRECISE BALANCE BETWEEN THE NEEDS OF THE GOVERNMENT AND THE CONTRACTORS. NEVERTHELESS, WE SUPPORT TITLE V AS IT WOULD CREATE A UNIFORM TIME FRAME FOR RESOLVING CLAIMS ON DOD CONTRACTS.

WE APPRECIATE THE OPPORTUNITY TO COMMENT ON THE PROPOSED LEGISLATION AND WOULD BE PLEASED TO MEET WITH YOU OR YOUR STAFF TO DISCUSS OUR COMMENTS.

/1/ MANAGEMENT OF THE DEPARTMENT OF DEFENSE - DEFECTIVE PRICING UNDER THE TRUTH-IN-NEGOTIATIONS ACT: HEARINGS BEFORE THE SENATE COMMITTEE ON GOVERNMENTAL AFFAIRS, S. HRG. 98-150-PART 2 (1983)

/2/ ID. AT 236 (STATEMENT OF DONALD KINLIN, SENIOR ATTORNEY, U.S. AIR FORCE).

/3/ ID. AT 200, 219 AND 236.

/4/ ID. AT 200 AND 225.

/5/ ID. AT 197 (STATEMENT OF HARRIS ANDREWS, CHAIRMAN, ASBCA).

/6/ ID. AT 203.