rity of contracts. And this is a far greater value to the Government than these relatively small monetary refunds.

Mr. CHARLES. I could not agree more.

Mr. HOLIFIELD. Proceed.

Mr. CHARLES. Our action in this case is in line with DOD policy on refunds, which has been presented to your committee by Secretary Ignatius. That policy was worked out jointly with the military departments, and we support it fully.

As indicated by Secretary Ignatius, this policy provides that if there is a contractual or other legal basis for adjustment, recovery action will be taken in every case. Additionally, DOD policy provides for seeking adjustment in any case in which a contractor has provided the Government negotiating teams with cost or pricing data which was incorrect, incomplete or not current, and where such data led the Government to enter into a contract it would not otherwise have agreed to. Recovery will be sought in such cases even though the conduct in question was not of such nature as to constitute a sufficient basis to support legal action to obtain recovery.

To bring the difference between the Air Force and GAO approach in this voluntary refund area into even sharper focus, I would now like to quote certain excerpts from one particular GAO report and comment briefly on it.

In report B-146732, dated January 7, 1965, the Comptroller General reported the following findings:

Our review of the leasing of electronic data processing equipment by the Lockheed Missiles & Space Co., Sunnyvale, Calif., has disclosed that rentals paid by the contractor for use of the equipment during a 20-month period were excessive because the manual time recording method used did not accurately record machine use time. This condition was subsequently corrected by the contractor through the installation of automatic timing devices on the electronic data processing equipment. On the basis of use time recorded by the contractor after automatic timers were installed, we estimate that excessive rental payments to the equipment manufacturer during the preceding 20 months amounted to about $604,000 essentially all of which has been charged to Government contracts.

Mr. Campbell then goes on to summarize the Department of Defense comments on this matter:

In a letter dated August 27, 1964, the Deputy Assistant Secretary of Defense (Procurement) agreed that automatic timing devices are more accurate in recording machine use time and have resulted in substantial savings in rental payments. He stated also that the Air Force representatives had met with the equipment manufacturer to discuss this matter and determine whether, under the circumstances, a price adjustment would be appropriate. The Air Force was informed by the equipment manufacturer that no adjustment was warranted on the grounds that rentals were computed in full accordance with the terms of the rental agreements and because the contractor's computations were based on manual time recording which was the system in use before automatic timers were developed. The Deputy Assistant Secretary believed, therefore, that it would be inappropriate to seek an adjustment for past rental payments under these circumstances.

Despite the fact that the manual system was the one intended by the parties and was called for in the rental agreements, GAO persisted in requesting refund action. If I may be permitted to quote one more excerpt from this report:

It is apparent, however, that, after the installation and use of the automatic timing devices, the amount of chargeable use time was significantly reduced.

Force and a detailed audit was made on two of the five forgings cited. in the General Accounting Office report. The audit generally supported the contractor's position with respect to profits over the production life of the forgings, as opposed to the more restricted samplings by the GAO auditors. Nevertheless, our audit did disclose large profit factors. On the other hand-and this is the important thing our investigation did not reveal any instance wherein the contractor had misrepresented prices or misled their customers. Since the contractor did not furnish cost data, did not execute certificates of current cost or pricing data, and would not accept defective pricing clauses, there was no contractual basis for seeking a price adjustment. Under the circumstances, the large profit factor in itself was not adequate justification for seeking a voluntary adjustment or impairing the integrity of the fixed-price contracts involved.

The point is that we entered into a binding contract with our eyes open. The Government, as well as the contractor, must respect its contractual obligations. We cannot, after the fact, treat a contract which we negotiated on a fixed-price basis as one entered into on some other basis. Like any party to a contract, we have to abide by the terms we agree to.

Let me digress for a moment from this prepared statement.

Would we, I might ask, make a voluntary payment to a contractor who had suffered a loss or received less than the anticipated profit? It seems to me that what is sauce for the goose is sauce for the gander. The sanctity of contracts is the bedrock of our commercial system. You nibble away at this and you nibble away at something far bigger than an occasional refund out of the millions of transactions in which we are involved.

Mr. HOLIFIELD. If the process of fixed-price contracts that have been awarded on a competitive basis is destroyed, and it would be destroyed by bringing pressures to bear which are extralegal in getting adjustments later on in these fixed-price contracts, what you say is very well taken, that what is sauce for the goose is sauce for the gander. And this is the thing that has bothered this committee, the fact that the Government has a one-way street to a man who may have a half dozen contracts and there is not a comprehensive audit to see that he gets a fair profit on five or six contracts, but there is a deliberate selection of one contract where his profit may run a little high and a complete ignoring of the contracts where he has either broken even or made a smaller profit than would be normal, or perhaps lost tremendous sums. And the Chair is in complete concurrence with your statement.

The point here is, the sanctity of contracts, the integrity of contracts, as you so well put forth in your second paragraph here on page 5. And if we are going to have contracts that we enter into with our eyes open, exercising our best judgment, we should be as the Government expected to complete our side of it just the same as by law the other side. has to complete their side regardless of their profit position. And this is a thing that has worried me.

It also worries me that we cannot help out the Treasury by getting the money that we would get through voluntary refunds. But I think your basic principle that is involved here is of far greater importance than a voluntary monetary refund would be in the Treasury because the cost of that monetary refund would be the destruction of the integ

rity of contracts. And this is a far greater value to the Government than these relatively small monetary refunds.

Mr. CHARLES. I could not agree more.

Mr. HOLIFIELD. Proceed.

Mr. CHARLES. Our action in this case is in line with DOD policy on refunds, which has been presented to your committee by Secretary Ignatius. That policy was worked out jointly with the military departments, and we support it fully.

As indicated by Secretary Ignatius, this policy provides that if there is a contractual or other legal basis for adjustment, recovery action will be taken in every case. Additionally, DOD policy provides for seeking adjustment in any case in which a contractor has provided the Government negotiating teams with cost or pricing data which was incorrect, incomplete or not current, and where such data led the Government to enter into a contract it would not otherwise have agreed to. Recovery will be sought in such cases even though the conduct in question was not of such nature as to constitute a sufficient basis to support legal action to obtain recovery.

To bring the difference between the Air Force and GAO approach in this voluntary refund area into even sharper focus, I would now like to quote certain excerpts from one particular GAO report and comment briefly on it.

In report B-146732, dated January 7, 1965, the Comptroller General reported the following findings:

Our review of the leasing of electronic data processing equipment by the Lockheed Missiles & Space Co., Sunnyvale, Calif., has disclosed that rentals paid by the contractor for use of the equipment during a 20-month period were excessive because the manual time recording method used did not accurately record machine use time. This condition was subsequently corrected by the contractor through the installation of automatic timing devices on the electronic data processing equipment. On the basis of use time recorded by the contractor after automatic timers were installed, we estimate that excessive rental payments to the equipment manufacturer during the preceding 20 months amounted to about $604,000 essentially all of which has been charged to Government contracts.

Mr. Campbell then goes on to summarize the Department of Defense comments on this matter:

In a letter dated August 27, 1964, the Deputy Assistant Secretary of Defense (Procurement) agreed that automatic timing devices are more accurate in recording machine use time and have resulted in substantial savings in rental payments. He stated also that the Air Force representatives had met with the equipment manufacturer to discuss this matter and determine whether, under the circumstances, a price adjustment would be appropriate. The Air Force was informed by the equipment manufacturer that no adjustment was warranted on the grounds that rentals were computed in full accordance with the terms of the rental agreements and because the contractor's computations were based on manual time recording which was the system in use before automatic timers were developed. The Deputy Assistant Secretary believed, therefore, that it would be inappropriate to seek an adjustment for past rental payments under these circumstances.

Despite the fact that the manual system was the one intended by the parties and was called for in the rental agreements, GAO persisted in requesting refund action. If I may be permitted to quote one more excerpt from this report:

It is apparent, however, that, after the installation and use of the automatic timing devices, the amount of chargeable use time was significantly reduced.

We believe that the rentals were paid on the basis of an inaccurate determination of use time; and, on the basis of the accepted method of meter measurement which was in effect at Lockheed, and now is in general use, a refund is justified. We are recommending, therefore, that the Department of Defense, in coordination with the equipment manufacturer and Lockheed, take action to resolve the matter with due regard for the interests of the Government.

Mr. HOLIFIELD. Of course, this is a judgment based on belief and on estimate, and not upon tangible facts which could be produced in a court of equity. Although it may be completely justified from a standpoint of the comparison of the workload under the manual time and the automatic time, this brings into play hindsight, and I assume this was on a fixed-price contract, was it?

Mr. CHARLES. The rental contract was.

Mr. HOLIFIELD. The rental contract was fixed price. And it was a customary method of doing business at that time before automatic timing was utilized. Therefore, would we not be in the position of going back for refunds on every technological improvement that might occur subsequent to

Mr. CHARLES. You are too smart. You are stealing my next paragraph.

Mr. HOLIFIELD. Oh, I will let you read it. I will quit testifying and let you read it. [Laughter.]

Mr. CHARLES. The GAO here has recommended that the Air Force seek a refund notwithstanding the fact that both parties entered into a contract which permitted and contemplated such a manual time measurement system. It is my feeling that refund action under such circumstances renders meaningless the contractual obligations of the parties.

In effect, this GAO report is suggesting that when an improvement is made the practices of the past should be reexamined to determine whether they resulted in any "unnecessary" cost to the Government which we should now try to recoup. To do so would, in our judgment, deter our contractors from introducing needed changes and improvements. Such a policy would have the effect of penalizing progress instead of encouraging it.

I think you phrased it better.
Mr. HOLIFIELD. Off the record.

(Discussion off the record.)
Mr. HOLIFIELD. Go ahead.

Mr. CHARLES. The second area of difference between the Air Force and GAO concerns the general area of pricing policy. Among the subjects I will discuss are the matter of negotiation on a total price basis versus separate negotiations on individual cost elements, and the cost-type approach to defense contracting versus the fixed-price approach.

În accordance with the principle that the total price negotiated is only as sound and equitable as the individual cost elements that make up the total price, GAO has taken the position that there is a need for adequate records evidencing the agreements which were reached with respect to each individual element of the price.

The position of the Department of Defense, detailing the advantages of negotiation on a total-price basis, has been set forth in Defense Procurement Circular No. 22, dated January 29, 1965. In essence, the

DOD position is that negotiation of a meaningful separate agreement on each significant cost element would often be impractical and almost always be uneconomical; that the contract prices will generally tend to be lower if negotiated on a total-price basis, since total-price negotiation results in one overall contingency factor and avoids contractor insistence on a separate contingency allowance for each cost element.

We agree, of course, that the various elements of a negotiation must be carefully considered in arriving at the total price. We disagree with the concept that each individual element should be negotiated with finality as a separate entity. The different approaches are illustrated by a report (OSD No. 2229) dealing with maintenance engineering target costs in connection with an aircraft production contract. This is the sustaining engineering effort required after development and throughout production.

GAO charged that the target costs were unsupported by cost experience or other factual data. Our reply to GAO pointed out that there were no target costs or target prices for maintenance engineering, but rather that a single target cost and target price had been negotiated for the entire production contract, of which maintenance engineering was but a part.

As I understand it, one of the reasons for GAO's emphasis on element-by-element pricing is that this would facilitate the job of postauditing contracts to find out whether any element of cost was increased as a result of defects in the original cost data. This postauditing function is necessary. We believe, however, as indicated in the Department of Defense Procurement Circular 22, that the totalprice approach is designed to give us the soundest price at the outset. The same GAO report illustrates another aspect of the difference between DOD and GAO on pricing policy; namely, the use of fixedprice contracts rather than cost plus fixed fee when uncertainties or risks are involved. Secretary Ignatius commented on this matter at length during his appearance before your committee. In accordance with DOD policy, the Air Force enters into fixed-price and incentive contracts as soon as sufficient pricing data is available to develop reasonable target prices. It is considered that this policy provides a contractor with maximum incentive to improve performance and reduce costs.

Of the two contracts involved in the case being discussed, the first was negotiated in April 1961, as a fixed-price redeterminable contract, since it was the first procurement of the aircraft. The target was reset in the course of negotiations conducted from November 1961, through January 1962, and the contract was converted to a fixed-price incentive type since this would provide the contractor with incentive to control and reduce costs and permit the Government to participate in the savings. The second contract, covering the follow-on procurement, was negotiated jointly with the target reset on the first contract, and the second contract also was fixed-price incentive. Over 40 percent of historical cost experience on the first contract was available at the time of the negotiations, and the information available was consistent with the contractor's estimating formula. The General Accounting Office concluded that the Air Force could have better safeguarded the Government's interest by deferring the establishment of