COMPTROLLER GENERAL REPORTS TO CONGRESS ON

AUDITS OF DEFENSE CONTRACTS

TUESDAY, JUNE 1, 1965

HOUSE OF REPRESENTATIVES,

MILITARY OPERATIONS SUBCOMMITTEE

OF THE COMMITTEE ON GOVERNMENT OPERATIONS,

Washington, D.C. The subcommittee met, pursuant to recess, at 10 a.m., in room 2247, Rayburn Office Building, Hon. Chet. Holifield (chairman of the subcommittee) presiding.

Present: Representatives Chet Holifield, William S. Moorhead, Frank J. Horton, Delbert L. Latta, and Howard H. Callaway.

Also present: Herbert Roback, staff administrator; Douglas Dahlin, attorney; Daniel Fulmer, attorney; Paul Ridgely and Robert J. McElroy, investigators.

Mr. HOLIFIELD. The subcommittee will be in order.

For the past 3 weeks, the subcommittee has been holding hearings on the subject of "Comptroller General Reports to Congress on Audits of Defense Contracts." We have heard testimony from the Assistant Secretary of Defense (Installations and Logistics), the Comptroller General, the Assistant Attorney General for the Civil Division of the Justice Department, the Controller of the Atomic Energy Commission, the Materiel Secretaries of the Army, Navy, and Air Force, and their supporting witnesses. We have discussed issues that have arisen in a fairly broad range of cases, and the witnesses have called other cases to our attention. We have looked at the roles of the various agencies concerned, at the practices and procedures being followed, and at the agency responses to GAO reports. We have heard about the voluntary recovery efforts that have been undertaken. I believe that we have a very good and unique record, which will be published as soon as it can be edited. We have brought to light and examined problems in procurement and contracting that are sorely in need of examination. We have heard some constructive recommendations and we hope to get others.

Having heard the Government side, this week we will hear industry witnesses. They represent companies which, in most cases, have been on the receiving end of the GAO reports. I made it clear at the outset of the hearings that we wanted to hear all parties who had useful information or constructive recommendations to present to the subcommittee. In a field so controversial as this, the subcommittee wants to get the full story on all sides. This is not only the fair thing to do but it is necessary in order to perform properly our reporting function to the Congress.

Since our time is more limited than we would prefer, to accommodate all witnesses, we may have to ask them to present their written statements for the record and to highlight the points in oral testimony and respond to questions. The written statements will be printed in full, however.

The first witness will be Mr. Karl G. Harr, president of the Aerospace Industries Association.

Mr. Harr, could you come to the witness chair and bring your associates.

Would it be possible for you to summarize this statement Mr. Harr?

STATEMENT OF KARL G. HARR, JR., PRESIDENT, AEROSPACE INDUSTRIES ASSOCIATION OF AMERICA, INC.; ACCOMPANIED BY MORTON WILNER, GENERAL COUNSEL

Mr. HOLIFIELD. Or would it be just as short for you to read it? Mr. HARR. I might read it. It is not very long.

On my right, Mr. Chairman, is Mr. Morton Wilner, general counsel of the Aerospace Industries Association.

Mr. Chairman and members of the subcommittee, my name is Karl G. Harr, Jr. I am president of the Aerospace Industries Association of America, Inc., an association comprised of the principal manufacturers of aircraft, missiles, and spacecraft, their propulsion, guidance systems, and related components.

First, I would like to thank the subcommittee for this opportunity to testify. The committee's recognition of the need for an open examination and free discussion of the GAO audits of Government contracts is, we believe, most timely, and we are happy to participate. As you have indicated, industry is increasingly concerned with some of the situations created by GAO audit reports and practices.

In the course of the hearings to date this committee and the Government witnesses that have appeared before it, have delved in considerable detail into some of the cases and the issues involving the GAO's reporting practices and their effects.

There will presumably be further consideration of these and other cases and issues in the course of subsequent testimony by representatives of industry.

Therefore it does not seem to me my most useful function, nor would I be the most competent witness for it in any case, to plow this same ground. Company representatives will be in a position to speak to specific cases. I shall instead, Mr. Chairman, seek to pinpoint as precisely as possible the nature of industry's concern.

To set the stage for an understanding of this industry's perspective, let me cite just a few particular facts about the aerospace industry. It is large, perhaps the nation's largest manufacturing industry, employing well over a million people and having annual sales of approximately $21 billion. It is a highly competitive industry. It is a low profit-(2.6 percent compared to a national average of 5.2 percent)net of sales after taxes industry. And it is an extremely technically oriented industry. It specializes in the management of highly complex systems interfaces and the research, development, and production of highest performance hardware at the outer limits of science and technology.

It sells approximately 85 percent of its products to the Government. In short, it is the Government's principal source of hardware for the support of the Nation's defense and space programs; as such it has become in a very real sense an instrument of national policy and an integral, if largely passive, partner in the procurement system evolved by the Government over the past decade or so.

Yet of course, it remains private industry subject to all of the economic disciplines of the free enterprise system.

In the service of these two tough masters, this industry has produced the technological miracles that underpin our national defense and space objectives, and has done so without loss of its economic viability. It has been able to do this only by virtue of radical managerial innovation, not only with respect to the hardware produced, but also with respect to internal management procedures involving, inter alia, cost control techniques, manufacturing standards and processes, and personnel motivation.

I believe each of these facts has some relevance to the matter at hand. Industry is, of course, deeply concerned with the issues that have heretofore been presented and discussed in the course of the testimony of Government representatives. Particularly the issues affecting integrity of contracts and Government involvement in contractor operations. Essential to the workability of any procurement system either within private industry or between private industry and the Government is the integrity of contracts. This integrity is undermined insofar as industry is concerned if the Government does not speak with one voice as, for example, when a contractor is penalized, publicly criticized or simply rendered uncertain as to whom he is accountable to even when carefully following practices established pursuant to the policies of the procuring agencies. It is also undermined if contracts are demonstrated to be unilaterally amendable after, and sometimes years after, completion; if contract finality is unduly postponed; or if by any of the several other procedures already discussed in the course of these hearings, it is possible to render that which has been openly arrived at, agreed to, held to, and performed by the contracting parties, not binding on both parties.

Government contracts must and do provide the basic structure for all dealings between Government and industry just as they must and do between separate entities within private industry. If the integrity of such contracts is undermined, the whole structure falls apart.

Equally essential to the workability of a procurement system based upon utilizing the skill, experience, and judgment of private industry is the principle that, within the limits dictated by the fully recognized need for adequate safeguards, sufficient opportunities must exist for the application of this skill, experience, and judgment. To the extent that these talents of private industry are diminished, overridden or substituted for, the objective of the system is thwarted, private industry's principal value to the Government is vitiated, and the taxpayer is short changed.

Moreover, oversimplified judgments on highly complex matters made years after the prevailing circumstances of a negotiation, singling out for review but one point from a total context of many interrelated points, hardly constitute an effective way of reviewing, reforming or adjudicating the quality of managerial performance.

There have been other important issues considered in the testimony to date which bear upon the problem of the effect of the GAO's practices upon the workability of the optimum procurement system; issues involving disputes as to pricing policy, efforts to encourage incentive contracting, consideration of total performance in appraising equities, and the like. All of these are also obviously of serious concern to that segment of industry which is involved in substantial dealings with the Government.

But the most significant aspect of industry's concern it seems to me lies elsewhere. It should be totally unnecessary to state that this industry, perhaps more than any other American industry, appreciates the need for an independent Government auditing agency such as the GAO. Because of our heavy involvement in support of vital national programs, this industry has been born and ripened "under audit" both self-imposed and externally imposed, to a degree probably not shared by any other industry. We defer to no other industry in experience with, understanding of and respect for the auditing function.

But we feel that the GAO, as the Nation's principal auditor is, in one key respect in its present mode of operations, proceeding from a false premise. And it is that fact which causes our greatest concern.

Simply stated, we feel that the GAO, whether or not in accordance with what Congress desires it to do, has become unduly involved in the exercise of managerial opinion both as to management judgments by the procuring agencies and management judgments by industry; that such opinion moreover carries inordinate weight because of the general assumption that what the GAO states is accounting or auditing fact; and that the result of these two factors is to inhibit the optimum procurement system in the national interest.

Auditing, both in-house and independent, is as universal as is the conduct of business itself or in fact any institutional disbursement of funds. The in-house auditor primarily performs a self-policing function under the control of the chief executive. If his auditing encroaches upon areas beyond his competence or jurisdiction, others in the organization, for instance the operating managers, will complain to the chief executive officer who is in a position to rectify the situation. Every industrial company and every Government agency performs this in-house auditing function. In the case of each defense contractor and each major Government procuring agency, it is a highly developed, high-priority function, with elaborate establishments both at headquarters and in the field.

The independent auditor has a different traditional role. His essential function is to check on the overall accuracy of accounting, including that of the in-house auditors, do it entirely free and independent of the control of the executive, and report objectively to those whom the institution is ultimately accountable; in the case of a company, the stockholders, and in the case of the GAO, of course, the Congress.

The sanctity of the independent auditor's position is justified by the need for a totally objective and honest accounting. Conversely, to the extent he may overstep this function, to that same extent he forfeits this sanctity. For example, if an independent professional audit of a private company contains opinion or judgments involving what are truly questions of managerial judgment rather than accounting fact, the manager makes that fact known to the stockholders.

But the Government's independent auditor operates in a very different environment indeed. Merely by virtue of the fact that it is the Nation's business that is being audited and the taxpayer's money that is being disbursed, an entirely different climate is created and entirely different results ensue from his reports.

The Comptroller General is, by a wide margin, the most important independent auditor in the Nation. Therefore, to a degree not shared by any other independent auditor, all will agree, the sanctity of his essential role must be upheld. Similarly, however, to a degree not shared by any other auditor in the Nation, he must exercise scrupulous care to avoid abuse of that sanctity.

For example, even without the slightest intentional coloration, GAO reports are news. With any coloration whatsoever, they readily become headlines. This constitutes great power indeed. In the cases considered by your committee there have been other examples of the peculiar power available to the Nation's chief auditing agency.

The point is that this power all stems from the general supposition of the public, of the press, and other news media, that what the GAO states is accounting or auditing fact, not merely opinion as to managerial judgment. That is where the false premise creeps in. For it is abundantly clear that the GAO has asserted a right to invade the province of managerial decision and to assert its opinion in such areas. In short, from a sanctity justified by its responsibility for auditing fact, it has sought to move into the management province of those who have both a competence and a responsibility not charged to the GAO. And because of the general supposition by the public that the GAO deals solely in fact rather than opinion, it has been able to make considerable but largely unremarked headway in that direction.

It is not easy for the Government procuring agency, the Government contracting officers or particularly the industrial contractor, regardless of the degree of his conviction as to the rectitude of his judgment, to stand up to a contrary opinion of the GAO, given the direct and indirect sanctions at the GAO's command.

You have heard Government witnesses aver their support of opinion from the GAO as to their policies and practices notwithstanding the fact that they may disagree with and reject such opinion. These witnesses have also pointed out, however, and I believe this needs underscoring, that the contractor is frequently the victim of such clashes of opinion. For it is he who often gets the most damaging adverse publicity even though he was scrupulously following the policies of the procuring agency. It is he who has to await the outcome of a dispute between Government agencies before he can be finally paid. And it is he who does not know, looking to the future, which policy and practice will ultimately prevail.

The contractor often finds himself at a loss. The sanctions available to the GAO gives its "opinions" real teeth. It injures and degrades a company to be publicly spanked for alleged misfeasance and malfeasance particularly when the allegation may not only be totally disproved, but may concern only a small part of a tremendously well-done job for which the company receives no public credit. It is offensive to be tried by headlines or to sense, correctly or not, that failure to knuckle under to a GAO opinion may in some way prejudice future contracts. It is damaging, both to the treasury and the future