I would like to thank Chairman McCain and all the members of the Subcommittee for this opportunity to provide written testimony for the record. POGO commends the Subcommittee for holding hearings on contract reforms that have subjected taxpayer dollars to potential waste, fraud, and abuse. Undoubtably, the Druyun/Boeing tanker fiasco has created a real ground-swell in Washington circles to review conflict of interest and procurement integrity issues. As a result we have heard of unprecedented investigations by the Defense Criminal Investigative Service of senior procurement officials who have gone to work for defense contractors, as well as the creation of the "Procurement Fraud Working Group" by U.S. Attorney Paul McNulty.
I am the Executive Director of the Project On Government Oversight (POGO) which investigates, exposes, and seeks to remedy systemic abuses of power, mismanagement, and subservience by the federal government to powerful special interests. Founded in 1981, POGO is a politically-independent nonprofit watchdog that strives to promote a government that is accountable to the citizenry. In the beginning, POGO (which was then known as Project on Military Procurement) worked to expose outrageously overpriced military spending such as the $7,600 coffee maker and the $436 hammer. After many successes reforming the military, POGO expanded its mandate to investigate systemic waste, fraud, and abuse in all federal agencies.
This testimony combines our unique position in the defense and contract oversight program areas. In the recent past POGO has exposed problems with Department of Defense (DoD) weapons systems, problems with the revolving door between the federal government and its top contractors, and numerous problems by so-called procurement or acquisition "reforms," including lack of competition, reduced oversight, and the elimination of transparency. I would specifically like to highlight two reforms that are very problematic: "commercial item" acquisitions and "other transaction authority" (OTA) – two contracting vehicles that are highly favored by government contractors.
POGO is 100% behind the concept of the government buying truly "commercial" goods and services. The commercial marketplace provides genuine checks-and-balances and therefore provides competition and lower prices. The problem arises in instances when the government is stretching the definition of "commercial" to include non-commercial items. In such cases, checks-and-balances are missing, as well as the contracting controls that provide the government with the ability to protect taxpayer dollars.
With regard to OTA, POGO concludes that their creation was based on a fallacy. Congress was lead to believe that hordes of "non-traditional" contractors who were afraid of government red-tape were clamoring to bring the government innovative good or services. OTA was created to welcome these new businesses into the government contracting fold. Well, the hordes never came. Instead, we are left with a system without contracting controls, and billions of dollars being awarded to "traditional" contractors who were already selling goods or services to the government. Although government statistics show that a few "non-traditional" contractors have stepped forward, those same reviews indicate that as much as 97% of OTA funds are going to traditional contractors.
Federal Acquisition Regulation (FAR) Part 12 governs the “Acquisition of Commercial Items” – items that are believed to be subject to competitive market forces. The purpose of such acquisitions is to reduce acquisition time, rather than paying contractors to develop unique items for the government’s use. “For example, contracting officials may reduce the time needed to solicit bids and award contracts by combining certain steps in the solicitation process, using streamlined evaluation techniques, and eliminating certain administrative requirements.” 1 The use of the “commercial item” contract vehicle is based on the premise that there is a “commercial” market for the desired goods or services. 2 Unfortunately, DoD has stretched the definition of “commercial item” and even went as far as to permit the purchase of items that do not meet the definition of “commercial item.” 3
Problems with “commercial item” purchases, however, date back many years. A March 1983 GAO report stated that “commercial item descriptions” (CIDs) were expected to maximize “the reliance on commercial packaging, packing, and marketing,” 4 thereby increasing “competition and, as a result, decreas[ing] costs.” 5 GAO noted, however, that CID purchases require “established commercial market acceptability, using recognized industry standards, instead of Federal specifications or standards, whenever possible, and requiring manufacturers to certify that the products they are selling to the government are the same as those in the commercial market place.” 6
To encourage such deregulation contractors argued that a “commercial” market ensures reasonable pricing. In practice, however, there are many inherent problems created when the government purchases goods or services using the “commercial item” contract vehicle. Through the Federal Acquisition Streamlining Act (FASA) 7 and the Clinger-Cohen Act, 8 “commercially” available items are exempted from much procurement oversight, such as the Truth in Negotiations Act (TINA) regulations, Cost Accounting Standards (CAS), cost or pricing data requirements, and audit access for examination of contractor records by the GAO or defense auditing agencies. 9 That problem is compounded by the government’s loose definition of "commercial," permitting “non-commercial items” to be labeled as “commercial items.” Similarly, items under the loose definition can be merely "of a type" sold to the public, rather than a product that actually is sold to the public. 10
The DoD Inspector General (DoD IG) noted that the loose definition of commercial items "qualifies most items that DoD procures as commercial items," with the result that: "This opens up a major loophole for sole-source vendors to charge prices that cannot readily be evaluated for reasonableness. This concern will continue to grow as more companies merge and the aerospace industry becomes more of a sole-source environment." 11
For instance, the C-130J military transport aircraft has been sold to the government as a “commercial item.” While not a single sale was ever made to civilians, oversight was loosened. The DoD IG has stated: “The Air Force conditionally accepted 50 C-130J aircraft at a cost of $2.6 billion even though none of the aircraft met commercial contract specifications or operational requirements.” 12The IG’s report also said:
The commercial acquisition strategy was unjustified, the Air Force did not properly manage the program, and the Office of the Under Secretary of Defense for Acquisition, Technology, and Logistics did not provide effective oversight. The Air Force bought the C-130J as a commercial item needing minor modification, but in the 8 years since the Air Force began contracting for the C-130J, Lockheed Martin has been unable to design, develop, or produce a C-130J aircraft that meets contract specifications. In addition, the Air Force did not determine whether the commercial version of the C-130J met the operational requirements before procuring the aircraft. 13
This "commercial" designation on the C-130J prompted Senator Tom Harkin (D-IA) in 1997 to fire off a letter of protest to Secretary of Defense William Cohen:
How can Atlas rockets and C-130J aircraft be considered "commercial" items? Obviously, these are not items found in the commercial sector. More importantly, they are not items that are priced due to the forces of supply and demand. Items bought solely or primarily by the federal government should not fall under the "commercial" definition.
With oversight regulations waived, the cost of wiring harnesses on the C-130J increased by five times their original price after the aircraft was designated "commercial," going from $91 to $453. The GAO offered this spare part price-hike as a real-world example of the difficulty involved in making the transition from pricing goods and services based on costs incurred to an ineffective commercial model in which factors other than cost are the principal means used to establish prices. 14
Similar government attempts were made to classify the C-17 cargo plane as a "commercial item." While at the U.S. Air Force, Darleen Druyun was a staunch supporter of the December 2000 proposal to acquire additional C-17 cargo aircraft while sidestepping financial oversight for Boeing. While the acquisition proposal would have been a financial bonanza for Boeing, it would have ultimately put billions of taxpayer dollars at risk. By categorizing such an item as "commercial," the government would have bypassed important pricing oversight controls that are only intended to be lifted for items that are truly "commercial" and whose prices are set by free market forces. A $232 million outsize cargo carrier with 173,300 lbs. capacity is clearly not a mass-market item that is sufficiently affected by the free market. Many other "commercial items" are purchased by the public, but with such low frequency that prices are by no means determined by the free market.
Generally, auditors are prevented from obtaining cost or pricing data on "commercial items." In a memorandum obtained by POGO, the extent to which contractors want to avoid showing cost data to government auditors is laid bare. In preparation for an Air Force visit, a Lockheed Martin official wrote:
Attached is our proposed agenda for the C-130J.
* * *
The cost information which we will agree to provide with the limited participation discussed last Friday is planned for the start of the second day.
The limited attendance cost discussion will include you, Major Stockman, and Mr. Clark from your team. As discussed, our intent is to provide information needed for you to complete your assignment, with the agreement that it will only be used for this assignment, it will not be provided to DCMC or DCAA [Defense Contract Management Command or Defense Contract Audit Agency], and you will control the information and only provide it to others with our concurrence.
As I am sure you understand, we are not trying to hide anything, merely attempting to preserve the commerciality of the program.15 (Emphasis added.)
One DoD auditor-turned-whistleblower who worked at the C-130J plant in Marietta, Georgia, spent months researching the cost of the "J" model, but was frustrated by his attempts to determine an actual, and fair, price for the aircraft. The auditor, Ken Pedeleose, said in a report to Congress that in June 1995 when the government designated the C-130J a "Regulatory Pilot Program," it "lost all insight into the C-130 operations."
In 2001, the DOD IG released a report that criticized the use of "commercial item" purchases, concluding:
The Office of the Under Secretary of Defense for Acquisition, Technology, and Logistics and the Defense Advanced Research Projects Agency have made different attempts over the last 3 years to inappropriately use FAR Part 12 contracts to acquire applied research. The lack of a commercial market and established catalog and market prices for applied research, and difficulties in determining fair and reasonable prices for services that do not exist in the marketplace makes the use of commercial item contracts for applied research inappropriate. 16
In 2000, Donald Mancuso, the DoD Deputy Inspector General, testified before Congress regarding the problem with "commercial item" purchases, stating:
In early 1998, we began issuing a series of audit reports on prices paid for aviation spare parts and equipment. As you may recall from your hearings at the time and intermittent publicity since, we found that prices paid under new, commercial type contracting arrangements were considerably higher than was the case when the same items were procured previously under "traditional" Defense contracts or ordering agreements.17
Before the curtain completely fell on access to "commercial" purchase data, the government was able to compare spare parts prices under the new "commercial item" designation to early data that had been supplied to the government. In its 1999 report, the DOD IG found that AlliedSignal had overcharged the government for spare parts by as much as 618%. 18 The irony is that these parts were bought under the new, much-touted "commercial" price system promoted by the Clinton Administration and Congress. The only way that the outrageous overcharging came to light was because the government still had pre-FASA and pre-Clinger-Cohen Act data to compare the old prices with the new "commercial" prices. POGO suspects that the same overcharges would be revealed in current "commercial items" if government auditors have access to cost or pricing data.
According to the January 1999 investigation by the DoD IG:19
- The government "paid Allied prices that were higher than fair and reasonable in FYs [Fiscal Years] 1996 and 1997 when compared to the noncommercial prices paid to Allied in previous years." The parts included items such as gearshafts, wheels, nuts, bearings, seals, filters, and valves.
- The Defense Department "paid a 54.5 percent premium for commercial parts from Allied" - in other words, were overcharged by more than 50%.
- For parts that AlliedSignal did not even make itself, but merely bought from original manufacturers or dealers and then sold to the government, some items were variously marked up by as much as 294%, 325%, and 618%.
- The Defense Department paid an even higher average markup in Fiscal Year (FY) 1997 (60.1%) than it did in FY 1996 (45.8%). It appears that in this case an Acquisition Reform "learning curve" is not being realized.
- Defenders of the acquisition system argue that the government paid higher prices because the prices included more stocking services - but the Defense Department failed to use the services.
The DOD IG report blacks out the names of specific spare parts that were grossly overpriced. Although contractors routinely claim such information is "proprietary," the real effect is that the public cannot easily find out how much they are overpaying for items they might recognize.
The IG report on AlliedSignal followed 1998 IG reports of overcharging under "commercial" contracts with Boeing and Sundstrand corporations. The earlier reports (see "Acquisition Deform: A Study in Hasty Deregulation," Project On Government Oversight Alert, October 1997) found that:
- Prices were inflated by more than 1,000 percent on a variety of spare parts. For example, the Boeing price for a commercially-available $24.72 "spoiler actuator sleeve" was $403.39 - a markup of 1,532 percent.20
- Sundstrand billed the government $6.1 million for parts that were worth only $1.6 million. 21
- Boeing charged $5 million for parts that were worth $3.2 million in the competitive market.22
- A contractor charged $76 for 57¢ screws. 23
- Another contractor charged $714 for an electric bell worth $46.68.24
The IG's 1998 report found that higher prices were paid for "commercial" items than had been paid earlier because: 25
- Although Acquisition Reform allowed the Sundstrand items to be purchased under loose "commercial" item rules, in fact "there was no competitive commercial market to ensure the reasonableness of the prices";
- Sundstrand "refused to provide DLA [Defense Logistics Agency] contracting officers with 'uncertified' cost or pricing data for commercial catalog items";
- Items were defined as commercial as long as they were merely "offered for sale, lease, or license to the general public" (emphasis added); and
- In the Boeing case,
"contracting officers accepted Boeing commercial catalog prices as fair and reasonable without adequate support for price reasonableness, even when DoD was the 'primary' customer procuring significantly larger quantities than other commercial customers and there was no competitive commercial market to ensure the price integrity. The contracting officers made no attempt to exert the leverage that a major customer ought to be able to exert to negotiate significant discounts, as is common commercial practice." 26
The purchase of "commercial items" under FAR Part 12 is on the rise. Since FY 2000, contract award dollars and actions have been on the rise. According to GSA's FY 2004 report, the government conducted 367,654 "commercial item" purchases totaling more than $50 billion. 27 In addition, "commercial item" purchases have increased in all categories. The chart below illustrates the increases in both government-wide and "commercial item" purchases.
Dollars in Billions
Dollars in Billions
% of All Contracts
Not only is the increased use of the "commercial item" contracting vehicle troublesome, but the Acquisition Reform Working Group (ARWG), largely made up of defense contractors, stated in its 2005 Legislative Agenda that it must continue to "push the envelop" regarding the government's use of "commercial items" purchases. As may be expected, ARWG's legislative agenda is complete with pro-contractor provisions that severely reduce or eliminate taxpayer protections – protections that allow agencies to oversee and audit government contracts. POGO's preference is that the "commercial item" designation is only used for goods and services whose price is set by the genuine "commercial" marketplace.
"Other transaction authority" is a term commonly used to refer to the DoD's authority to enter into transactions (OT agreements) other than contracts, grants or cooperative agreements. 30 DoD has temporary authority to award such agreements in certain circumstances for basic, applied, and advanced research projects.31 Its authority was expanded to allow the Director, Defense Advanced Research Projects Agency (DARPA), to enter into OT agreements to carry out prototype projects that are directly relevant to and weapons or weapon systems proposed to be acquired or developed by DoD.32 OTA is a customized agreement rather than contracts that can be specifically tailored based on the government's needs.33 The inherent problem, however, is that rather than the government controlling what it needs, the OTA contractors are placed in the powerful position of saying "here's what we will do for you."
"Other Transactions" acquisitions generally are not subject to the federal laws and regulations governing procurement contracts. Therefore, OTA is exempt from the usual contracting controls and oversight mechanisms set forth in contracting statutes, the FAR (in particular Truth in Negotiations Act) (TINA) regulations and Cost Accounting Standards (CAS), DFARS, audit access for examination of contractor records by the GAO or defense auditing agencies, and Small Business Act requirements for small business participation.34 Mirroring the intended reasons behind "commercial items," OTA was created to lure non-traditional defense contractors to bring innovative ideas to the government.35 The numbers do not support the government intent, however, with 72% of the research and 97% of the prototype OTA funding going to traditional DoD contractors in the late-1990s.36 Now we are hearing a new explanation for OTA – that the primary benefit to contractors is that they can fully protect their intellectual property rights. In addition to the elimination of contracting controls, the companies that enter into OT agreements retain their ability to make a dollar from programs that were funded by Uncle Sam.
Soon after DoD started using OTA, the DOD IG began documenting problems with those acquisitions. In 1998, the DOD IG reported on problems for 28 OT agreements awarded by DARPA.37 One recommendation was for better monitoring of the actual costs against the funds paid and inconsistencies with audit provisions.38 One year later, the IG reiterated concerns with OTA, stating:
DoD officials did not receive adequate expenditure reporting needed to monitor "Other Transaction" efforts, did not adjust milestone payments when needed, forfeited interest, and did not receive final research reports. The underlying causes were the lack of management guidance, and a lack of quantifiable performance measures to assess costs and benefits. The Department has issued additional guidance, but establishing the performance measures has been difficult for the Department.
* * *
Given the inapplicability of traditional controls to "Other Transactions," we believe that if this authority is extended to billion dollar production runs of equipment, additional scrutiny of pricing for sole-source items will be needed to protect DoD and taxpayer interests. In these cases, the Department should require access to cost or pricing data, plus audit access for the Defense Contract Audit Agency, in order to ensure fair prices.39
In 2000, the DoD Deputy IG Donald Mancuso pleaded with Congress to reign in OTA, testifying that "Congress may consider legislative proposals for other transactions this year. Given the inapplicability of traditional controls to other transactions, any expansion of the authority for other transactions should provide the needed protections both for the Department and the American taxpayers."40
Two major DOD acquisitions have come under OTA status: missile defense and Future Combat Systems (FCS) programs. As stated above, these programs are shielded from normal contract oversight mechanisms and proceed virtually unregulated. The real issue is what are we getting for our dollar.
On January 2, 2002, Secretary of Defense Rumsfeld issued a memorandum regarding the direction of the missile defense program. That memorandum included a directive stating that "to encourage flexibility acquisition practices, I delegate to the Director, MDA, authority to use transactions other than contracts grants, and cooperative agreements to carry out basic, applied, and advanced research."41
In 2002, DARPA started awarding "other transactions" for development work for the Future Combat Systems (FCS) program. Although only $20 billion awarded, the total value of the FCS program is believed to run as high as $120 billion. That makes the FCS program the largest OTA purchase to date. Army officials have countered by claiming that FAR provisions apply to the FCS program. That statement is misleading in the sense that OTA is not subject to the FAR. Last year, however, DoD finalized FAR-like regulations for "other transactions" for prototype projects, although none of those regulations offered oversight controls that protect federal funds (i.e., TINA and CAS).
POGO is concerned that both the missile defense and FCS programs are ripe for abuse and the use of OTA truly eliminates protections of hundreds of billions of taxpayer dollars. The OTA mechanism waives many of the financial oversight requirements of typical contracts for goods or services with the aim of attracting so-called non-traditional" defense contractors. "Other transactions" allow contractors to avoid taxpayer protections and transparency requirements in the contract statutes and regulations, which provide protections to ensure fair and reasonable procurement prices. OTA, however, is exempt from those protections and can exempt a defense contractor from undergoing government audits or providing the federal contracting agency and government auditors with access to the contractor's pertinent records.
1. Restore the definition of "commercial items" to those actually sold to the general public in significant quantities, rather than the current loosened definition: an item not necessarily sold to the public, but merely "offered for sale," or "of a type" offered for sale. Today, some "commercial items" never actually experience sales to the public, allowing the defense contractors that produce them to charge exorbitant amounts while pretending that a competitive commercial market is keeping prices in line. Such items should not be exempt from the usual oversight (TINA and CAS); and
2. Stop the proposed rule on use of Time and Material and Labor Hour (T&M and LH) contracts using so-called "commercial item" FAR Part 12 provisions. This attempt is just another way of relieving contractors from oversight on flexibly-priced contracts. T&M and LH contracts could still be used, but they would have to include traditional oversight clauses, which FAR Part 12 prohibits.
1. Restore the original intent to bring innovations to the public from non-traditional government contractors, rather than throwing billions of dollars with no oversight controls to the government's top vendors (i.e., prohibit any contractor who has accepted a FAR contract from being eligible to receive an OTA); and
2. Renegotiate such agreements under contracting vehicles that provide taxpayer protections (i.e., FAR Part 15).
General Contract Reforms:
1. Increase competition -- especially for Indefinite Delivery/Indefinite Quantity (ID/IQ) contracts (e.g., GSA schedules, Governmentwide Acquisition Contracts (GWACs), and other multi-agency contracts);
2. Increase oversight for flexibly-priced contracts (e.g., cost-reimbursement contracts, incentive-type contracts, and T&M and LH contracts); and
3. Increase transparency -- by requiring all opportunities (unless there is a security exception), and regardless of how phrased (e.g., contracts, orders, Blanket Purchase Agreement (BPAs), task or delivery orders under schedules GWACs, etc.) to be posted to Fed Biz Ops.
2. 41 U.S.C. § 403(12) (defining "commercial item"). See 10 U.S.C. § 2376 (defining "commercial item"); FAR 2.101(b) (defining "commercial item"), FAR 12.101(a) ("Conduct market research to determine whether commercial items or nondevelopmental items are available that could meet the agency's requirements."), and FAR 12.201 ("Public Law 103-355 establishes special requirements for the acquisition of commercial items intended to more closely resemble those customarily used in the commercial marketplace.").
5. Id. at p. 1.
6. Id. at p. 3.
9. See FAR 12.102(f)(2) and 15.403-1. There is a debate over whether government audits can be conducted. A problem exists, however, because contractors supplying "commercial items" do not supply the government with cost or pricing data and therefore the auditors do not have data to verify.
13. Id. at ii.
14. Statement for the Record, Henry L. Hinton, Jr., Assistant Comptroller General, National Security and International Affairs Division, General Accounting Office, before the House Committee on Government Reform, Subcommittee on Government Management, Information, and Technology, Federal Acquisition: Trends, Reforms, and Challenges, GAO/T-OCG-00-7, March 16, 2000, at p. 10.
17. Donald Mancuso, Deputy Inspector General Department of Defense, Statement made before the Subcommittee on Readiness and Management Support of the Senate Committee on Armed Services on Defense Acquisition, April 26, 2000, at p. 9. Hereinafter Mancuso Statement.
19. Id. at p. I-10.
23. Department of Defense Authorization Ace for Fiscal Year 1999 Report on Authorizing Appropriations, Senate Armed Services Committee, Rpt. 105-189, and "U.S. Senate Panel Tells Pentagon to Stop Parts 'Pricing Abuses,' " Tony Capaccio, Bloomberg Business News, May 29, 1999.
34. Statement of Eleanor Hill, Inspector General Department of Defense, For the Subcommittee on Readiness and Management Support Senate Committee on Armed Services On Acquisition Reform in the Department of Defense, March 17, 1999, at p. 16. Hereinafter Hill Statement.
38. Id. at p. 16-17.
39. Id. at p. 18-19.
41. Secretary of Defense Donald Rumsfeld, Memorandum for Deputy Secretary of Defense Secretaries of the Military Departments et al., Missile Defense Program Direction, January 2, 2002, attachment at p. 2.