At the same time, we are going to review the status of some 70 audit reports, to see what the agencies have done, to find out what recoveries have been made, and to find out what specific issues and experience have been gained from those reports issued in 1964, and from other representative cases. I might add that these hearings are open to all parties in Government, industry, or professional associations who may wish to testify and wish to bring to the attention of the subcommittee any matters of importance relevant to the subject matter of these hearings. Several industry association have indicated an interest in presenting information or testimony, as well as several companies affected by the GAO audit procedures. We will announce future witnesses as soon as definite requests to appear are received by the subcommittee. Mr. Secretary, as chairman of the subcommittee, nay I welcome you and your companions to the witness table. Would you like to introduce them at this time? STATEMENT OF PAUL R. IGNATIUS, ASSISTANT SECRETARY OF DEFENSE (INSTALLATIONS AND LOGISTICS); ACCOMPANIED BY GRAEME C. BANNERMAN, ASSISTANT SECRETARY OF THE NAVY (INSTALLATIONS AND LOGISTICS); AND JOHN M. MALLOY, DEPUTY ASSISTANT SECRETARY OF DEFENSE (PROCUREMENT) Mr. IGNATIUS. Yes, sir; I would, Mr. Chairman. On my right is Mr. Graeme C. Bannerman, Assistant Secretary of the Navy for Installations and Logistics. Until just recently, Mr. Bannerman was Deputy Assistant Secretary of Defense for Procurement. He served with great distinction in that assignment and was promoted just a matter of some weeks ago. Therefore, he is here today in a sense as Assistant Secretary of the Navy, but more particularly as the Department of Defense's expert and authority in procurement matters. On my left is Mr. John M. Malloy, who was sworn in just a few weeks ago to replace Mr. Bannerman, and is now the new Deputy Assistant Secretary of Defense for Procurement. Mr. HOLIFIELD. May I congratulate both of you gentlemen on your recent promotions. Mr. Bannerman has been before us before. We are glad to have you again with us. And we congratulate you on your promotion to this new office. Mr. BANNERMAN. Thank you very much, Mr. Chairman. Mr. HOLIFIELD. You may proceed, sir. Mr. IGNATIUS. Thank you. INTRODUCTION Mr. Chairman and members of the committee, I appreciate the opportunity of appearing before you today to discuss the subject of Comptroller General reports to the Congress on audits of Defense contracts, the action which we take on these reports, and our views concerning them generally. As I have said earlier, with me today. are Mr. G. C. Bannerman, Assistant Secretary of the Navy (Installations and Logistics), and Mr. John M. Malloy, just recently appointed as Deputy for Procurement in my office. DOD PROCEDURES FOR HANDLING GAO REPORTS Initially I believe it is important for the committee to know that the Secretary of Defense takes a personal interest in all reports received from the Comptroller General concerning the activities of the Department of Defense. He has personally directed that prompt, clear, and positive action be taken on all such reports. He has issued comprehensive instructions requiring the systematic consideration of all GAO reports and he has assigned members of his own staff to review the reports and the replies made to the Comptroller General. Under the procedures established by Secretary McNamara, each report is assigned either to the Secretary of the military department concerned or to an Assistant Secretary of Defense when more than one military department is concerned. Receipt of each draft report and each final report requires a review, an evaluation, and the preparation of a proposed response to the Comptroller General. These responses include our comments on the findings and recommendations made in the report. In response to draft reports, our goal is to help assure that the final reports which are sent to the Congress are as accurate and objective as possible. We tell GAO whether we agree or disagree with their findings and, in those cases in which we agree, we let GAO know the specific corrective actions which we intend to take. Each response made to the Comptroller General on a draft report or a final report is reviewed and approved by the Secretary of Defense or the Deputy Secretary of Defense before it is transmitted to the Comptroller General. These reviews of the draft and final reports and the proposed replies to the reports are processed through channels within the military departments and the Office of the Secretary of Defense. The procedures and controls that are followed enable all intervening top management officials to become knowledgeable of the Comptroller General's allegations, his recommendations, and the proposed departmental action. It is apparent I am sure you will agree, that we take these reports seriously and regard them as a useful source of management assistence. NUMBER OF GAO REPORTS ON DEFENSE CONTRACTING We have witnessed during the past 3 years substantial increases in the number of draft and final reports issued by the GAO. The increase in GAO reports directed to all DOD functions went up from 206 draft and final reports in 1962 to 544 draft and final reports in 1964 an increase of 164 percent. Reports dealing exclusively with procurement increased from 74 draft and final reports in 1962 to 213 such reports in 1964. We do not believe that the increase in the number of reports is a barometer of the number of deficiences in procurement. We do believe that whenever hundred of auditors and investigators are assigned to the job of critically examining the detailed operation of any large enterprise, public or private, on an after-the-fact basis, instances will be found of transactions that could have been handled more efficiently. Secretary McNamara, in his appearance before the Joint Economic Committee last month, commented on this subject and we feel that his remarks are pertinent to the matters under consideration by your committee. The Secretary said: * in an enterprise as large and complex as the Defense Establishment, some of the actions taken will not turn out as planned and some outright mistakes will be made no matter how the Department is organized and managed and, indeed, no matter who the managers happen to be. What is involved here is an enterprise employing almost 4 million full-time military and civilian personnel *** we spend almost $30 billion a year for goods and services purchased from the private economy * * We execute some 10 million contract actions * * *. Ample opportunities for human error or poor judgment exist, and I might add that these deficiencies are much more easily recognized after the fact than before. This very real limit of human infallibility can be frankly recognized without in the least condoning the results. I can testify from my own experience that it exists in industry as well as in Government * Because there is this opportunity for error in large organizations, public or private, that Secretary McNamara described, it is necessary to have audit reports that identify weaknesses and suggest corrective actions. Audit reports, whether prepared by our own staffs or the GAO, are thus a source of management assistance. It is inevitable that there will be differences of opinion between the auditor and the operator, and I would like at this point to describe some of the disagreements we have had with GÃO with respect to procurement policy and contract methods. AREAS OF DISAGREEMENT BETWEEN GAO AND DOD We have supplied your committee regularly with copies of our responses to GAO reports. As a consequence you have had the opportunity to consider our position in each case in light of the pertinent facts and circumstances. I shall today, in response to suggestions contained in your letter of April 27 to Secretary McNamara, review the major areas of disagreement between GAO and the Department of Defense with respect to procurement policy. The Materiel Secretaries, who will appear at a later date in these hearings, will be prepared to discuss in detail the elements of each of the cases involving their respective departments. We have selected three areas of difference for presentation to the committee. These areas are: Integrity of contracts; pricing policy; Government involvement in contractor operations. I would like to discuss some of the issues involved in these important areas and present the views of our Department. INTEGRITY OF GOVERNMENT CONTRACTS Questions involving the integrity of defense contracts represent a frequent area of disagreement with GAO. The most persistent problem of this type relates to the question of when and under what conditions a voluntary refund should be sought from a contractor. Other problems in this area arise when GAO directs the withholding of payments under contracts which have been fully performed, or when GÃO takes actions that affect contractual remedies for the orderly disposition of contract claims and disputes. With respect to the question of refunds, it is important to distinguish voluntary refunds from situations in which the Government has a contractual or other legal right to a refund. Legal grounds often exist for the recovery of money paid to contractors, and where this is the case, there is little disagreement, if any, between the positions of GAO and DOD. For example, pursuant to Public Law 87-653, negotiated contracts now contain the "Price Reduction for Defective Cost or Pricing Data" clause which gives the Government the right to determine whether the contract price was increased by any significant amount, because the contractor furnished cost or pricing data that was incomplete, inaccurate, or not current. In the event of such a determination by the Government, the price may be reduced accordingly, and if the contractor does not agree, he may appeal the determination in accordance with existing disputes procedures. The Government's right to an adjustment in such cases is thus clearly established by the terms of the contract. Voluntary refunds, on the other hand, are refunds requested in circumstances where no contractual or other legal right of recovery exists. From a review of many reports, it appears that GAO generally recommends that a voluntary refund be obtained whenever prices are found by the GAO to include "unnecessary," "excessive," or "unwarranted" costs. The Department of Defense has frequently agreed with GAO recommendations but in many cases we have disagreed either because we did not concur in the facts as stated in the report or because we concluded that the circumstances did not meet the conditions specified by DOD policy. The DOD position in regard to requesting voluntary refunds is predicated upon the general proposition that the Government, like any private individual, is bound by the agreement which it enters into and that this must be the first and overriding consideration in any determination as to whether or not voluntary refunds should be sought. With this in mind, DOD has published a policy on seeking voluntary refunds which states as follows: Seeking a price adjustment without a claim of legal right will be considered an extraordinary remedy to be resorted to only when it is determined that both of the following conditions exist: (a) The Government was overcharged in the pricing of a defense contract or inadequately compensated for the use or purchase of Government-owned property, and (b) retention by the contractor or subcontractor of the amount in question would be contrary to good conscience and equity. The seriousness with which we regard any request for a voluntary refund is indicated by the detailed guidance contained in the policy statement stressing the need for caution and restraint and prohibiting the indiscriminate exercise of this extraordinary remedy. The policy provides that the decision as to whether or not to seek an adjustment is to be made at a sufficiently high level in the military departments to assure an adequate consideration of the facts and equities in each case and to assure a reasonable consistency of approach in handling such cases throughout DOD. In applying this policy, the military departments have, as noted above, often concurred in the recommendation by GAO to seek a voluntary refund. However, to provide an understanding of the types of cases in which the military departments have not agreed, we cite the following examples: (1) We did not seek a voluntary refund in the Bainbridge case (report B-146718 dated March 18, 1964-OSD case No. 1794), because 48-132-652 we did not agree that there was any overpricing. The pricing decision in this case was arrived at after unusually prolonged negotiations. The contractor took a hard bargaining position but there was no overreaching of any sort and there clearly was hard bargaining on both sides. The decision reached by the Navy was a difficult one but it was made deliberately and only after thorough consideration of the pertinent facts. This was an eyes-open situation, and in our view, an attempt to seek a price adjustment was unwarranted. (2) We did not seek a voluntary refund in connection with the report dated January 15, 1963 (B-146757-OSD case No. 1603), even though we stated that the contractor was wrong in adopting a take it or leave it position. Again this was an eyes-open situation. We knew what we were doing, there was no overreaching, we were not misled in any way. Accordingly, we concluded that no request for a voluntary refund was in order. (3) We did not seek a voluntary refund in the report dated August 28, 1964 (B-146892-OSD case No. 1559), or the report May 21, 1964 (B-146886-OSD case No. 1802), for reasons similar to those stated above and also because, as a practical matter, the reopening of past overhead negotiations would have required the reopening of all other overhead elements which we felt to be generally in our favor. (4) We did not agree with GAO's recommendation to withhold payments to the contractor in the report dated August 24, 1964 (B– 146901-OSD case No. 1896), because we found that procurement of the unneeded spare parts was not the result of any failure on the part of the contractor, as contended in the report, but was due instead to the action of the Government in accelerating deliveries and thereby disrupting the orderly process of spare parts provisioning. We have from time to time reviewed our policy on seeking voluntary adjustments and, on balance, we believe it continues to be a sound policy. We will continue to give the most careful consideration to GAO recommendations in this respect but we believe it is essential to proper contracting that we seek adjustments only when determinations are made, pursuant to an established and consistently followed policy, that such adjustments are fully warranted in each individual case. Another related problem area which comes under the category of "integrity of contracts" involves cases where, after the contracts had been fully performed, GAO declared the contracts illegal and took steps to withhold payment. A case in point is the report dated June 2, 1964 (B-146894 OSD case No. 1863), involving a formally advertised contract for runway construction at Andrews Air Force Base. This contract was awarded in accordance with established procedures and was legally approved by the Department of the Army. Five years after award of the contract and two years after completion of the work, GAO stated that the contract was illegal and requested that payment be stopped on the balance of approximately $200,000 still due the contractor. We consider that, under these circumstances, the action by the Government in withholding funds and repudiating its commitment was inappropriate. We believe that contractors should have reasonable assurance that they hold binding contracts with the Government and that contracts entered into and performed in good faith will not thereafter be voided. |