General Accounting Office of Air Force contract No. 33(038)-18503 between General Motors Corp. and the Government. I congratulate you on the magnificent job which your staff has performed in bringing these facts to light and presenting them for the information of the Congress. I am today referring the matter to the Special Investigations Subcommittee of this committee, which is authorized under House Resolution 67 to examine into matters of this sort. You will hear immediately from the chairman of that subcommittee. Sincerely yours, CARL VINSON, Chairman. JULY 19, 1957. Hon. JOSEPH CAMPBELL, Comptroller General of the United States, Washington, D. C. DEAR MR. COMPTROLLER GENERAL: Hon. Carl Vinson, chairman of the Armed Services Committee, has handed to me and I have reviewed your letter of this date, No. B-125054, with which you transmitted your report to the Congress on Air Force contract 33 (038)-18503. I believe this is a matter of transcendent importance. Accordingly, I have set the matter for hearing before this subcommittee on Monday, July 22, 1957, at 10 o'clock. You realize, of course, that the subcommittee is now in consideration of a pending matter, but I believe that its work will have been completed on or before 10 o'clock. In any event, I trust it will be convenient to have your staff available to discuss this matter with the subcommittee at that time. This is a matter which requires prompt and definitive action. I am very much impressed with the thoroughness of the report and the complete detail which has been presented, and I feel that the subcommittee must be fully acquainted with it at the earliest opportunity so that proper action may be taken in the premises. Sincerely yours, F. EDWARD HÉBERT, Chairman. Mr. COURTNEY. Mr. Chairman, Mr. Powers has a prepared and written report. I would ask that he be permitted to proceed in order. Mr. HÉBERT. Mr. Powers, present your statement in your own order. And I will ask the cooperation of the members of the committee that they allow you to finish your statement before they begin their examination. Mr. COURTNEY. A portion of the figures which may be detailed and repeated, at least the more important ones, are on the board, and reference will occasionally be made to the figures on the board as well as in the printed document. Mr. HÉBERT. All right, Mr. Powers. TESTIMONY OF LAWRENCE J. POWERS, DIRECTOR OF DEFENSE AUDITING AND ACCOUNTING DIVISION, GENERAL ACCOUNTING OFFICE, ACCOMPANIED BY W. A. NEWMAN, DEPUTY DIRECTOR, STEPHEN HAYCOCK, JAMES HAMMOND, AND DAVID LAMBERT Mr. POWERS. Mr. Chairman and members of the Subcommittee on Special Investigations of the Committee on Armed Services, we appreciate the opportunity to appear before your subcommittee to explain at your request our report to the Congress of the United States, dated July 19, 1957, on review of Department of Air Force contract AF 33 (038)-18503, with the General Motors Corp. We have examined the negotiation of the prices under Department of the Air Force contract AF 33 (038)-18503, dated April 25, 1952, which was awarded to the General Motors Corp., Buick-Olds-Pontiac assembly division, Kansas City, Kans., by the Headquarters Air Materiel Command, Wright-Patterson Air Force Base, Ohio. Our examination was made pursuant to provisions of the Budget and Accounting Act, 1921 (31 U. S. C. 53), the Accounting and Auditing Act of 1950 (31 U. Š. C. 65), and the Armed Services Procurement Act of 1947, as amended by the act of October 31, 1951 (41 U. S. C. 153 (c)). Contract AF 33 (038)-18503 was for the manufacture of 599 F-84F airplanes, plus related spare parts, and was a negotiated fixed-price contract with a price-redetermination clause which provided for an initial mandatory redetermination of prices to be applied retroactively and prospectively upon acceptance of the 71st airplane and a second mandatory repricing to be applied prospectively upon acceptance of the 299th airplane. The contract did not place a limit on the amount of upward or downward price revision. The contract provided also for optional repricings for undelivered airplanes after acceptance of the 71st airplane at intervals of not less than 90 days on demand of either party, but this option was not exercised by either party. The mandatory price redeterminations, which resulted in establishing a final price of $375,848,000, were conducted in September 1954 and March 1955. The contract was substantially completed in May 1955. In the retroactive pricing of the first 71 airplanes, the contractor was reimbursed his costs plus a profit of 5.9 percent on cost. We consider the negotiated price of that segment to be reasonable in relation to the minimum risk involved. The remaining comments in our report apply primarily to the negotiation of prospective prices for the second segment of 228 planes and the third segment of 300 planes. Our findings and conclusions were presented to the Air Force and General Motors Corp. in the form of draft reports, and the comments received from those parties have been recognized in our report, and included as appendixes A, B, and C. Summary: The financial results experienced by the contractor on the forward portion of the contract and spare parts, compared with those contemplated in negotiations, are summarized below: Contract price established in redetermination___. The contractor's experienced profit__. Profit contemplated---- $208, 998, 000 176, 057, 500 32, 940, 000 15, 481, 300 17, 459, 200 Experienced profit in excess of contemplated profit-----Selected data with respect to prices negotiated and profits realized, Mr. Chairman, is contained in a tabulation on page 3 of our report. With your permission, I would like to insert that tabulation into the record. Mr. HÉBERT. Without objection. Mr. POWERS. It is my understanding that this summary on the blackboard is the same as the tabulation appearing on page 3 in our report. Mr. COURTNEY. It is, Mr. Chairman, with the exception of the explanatory notes which Mr. Powers will give in the course of his remarks. The first series of lines, before the broken line, is the table referred to on page 3. Mr. HÉBERT. It will be made a part of the record. (The table is as follows:) 1 Includes $1,240,500 to cover engineering changes for which the related costs were not segregated from airplane costs. We were unable to determine from the record of negotiations the contemplated costs and profit comprising the price negotiated for the retroactive portion of the contract. According to the record of negotiations, a profit rate of 8 percent was agreed upon at the time this contract was placed. The contractor's price proposals, as well as the final prices negotiated, included a profit factor of 8 percent or less. The contractor's letter to AMC dated Apr. 25, 1951, set forth General Motors' agreement to apply in contract bids on F-84F airplanes a profit rate of 8 percent of costs and further indicated that all contract bids would be subject to redetermination and General Motors would benefit to the extent that savings are accomplished through good performance. (See appendix C, exhibit A.) Mr. POWERS. In response to our request for comments on the final draft of this report, General Motors Corp.'s reply, dated June 18, 1957, stated that the absence of a demand by either party under the repricing option of the contract indicated reasonableness of the prices negotiated. Contractor's comment on this is contained on page 31 of appendix C to our report. We do not agree with this assumption. From the absence of a demand for repricing by General Motors, it is reasonable to assume that the contractor was satisfied with the prices, but the absence of a demand by the agency does not mean that the Air Force considered the prices to be reasonable, since the Air Force was not in a position to compare the contract prices with the contractor's continuing cost experience. The cost data furnished by the contractor to AMC was not adequate for ascertaining the desirability of exercising price revision options nor did the cost data furnished conform with provisions of the contract. From the tabulation that I have referred to previously and as shown on the blackboard, it can be seen that the Air Force reduced the estimated costs proposed by the contractor for the forward portion of the contract by $9.4 million. The contractor, in his comments dated May 3, 1956, as shown in appendix B of our report, and in his later comments dated June 18, 1957, attempted to minimize the significance of our findings by maintaining that our observations were applicable only to the original price proposed by the contractor and that the items totaling $8,322,000 which we questioned in the contractor's pro posal were more than offset by the $9.4 million. In our examination, full recognition was given to the $9.4 million reduction made in negotiations and reflected in the negotiated price. However, our findings, which are summarized below and discussed in detail hereafter, showed that substantial price reductions in addition to the $9.4 million should have been attained. First, in dealing with the known reductions in the subcontractor's prices, the contractor's actual costs of materials purchased from outside suppliers for the second segment covering 228 airplanes were approximately $4,350,000 lower than the estimated costs of such materials included in his price proposal. Of this total reduction in material costs, about $1,700,000 was known to the contractor prior to the date of his price proposal for the first forward price redetermination but was not recognized in that proposal, which stated that: The unit prices shown for materials purchased from outside suppliers are firm and are supported by purchase orders. No exception was taken in negotiations to the contractor's estimate for materials purchased from outside suppliers. An example of the known price reductions making up the overstatement of $1,700,000 is the reduction in the price of an assembly purchased from Vendo, Inc., which was shown in the contractor's proposal at a unit cost of $1,507 for 228 units. However, this price applied to only the first 68 assemblies and the remaining 160 assemblies were priced at approximately $400 per unit, a total reduction of $177,000. Although the supplier and the contractor had redetermined the price of this assembly prior to the submission by the contractor of his proposal, the reduction in price was not recognized in the proposal. Since the contractor had firm agreements with subcontractors at prices lower than those represented as his anticipated material costs, the use of only the higher prices constituted an incorrect statement of the prices to be paid for purchased parts. This statement was submitted as a part of the cost data to be considered and acted upon by the Government in negotiating revised prices and worked to the benefit of the contractor and to the detriment of the Government. The incorrect statement and the contractor's excessive estimates of these and other costs in the price negotiations have resulted, in our opinion, in unreasonably high prices being paid by the Government. In commenting on our observations, the contractor furnished us with a copy of a letter to AMC dated October 25, 1956-see appendix C, exhibit D, page 43, of our report-in which General Motors ac knowledged that, in some cases, for the second segment of 228 planes they had firm prices for components applicable to a portion of the planes and lower prices for the components for use on the remainder of the planes of that segment. General Motors stated that in such cases they generally used the highest prices in their proposal for the entire segment rather than the average or actual prices. The reasons given by General Motors were: (1) To protect the corporation in the event the Air Force terminated the contract or requested a further price redetermination during the second segment of the contract; and (2) to provide for the possibility, in proper circumstances, of granting suppliers upward adjustments of firm prices of materials. We believe that the contractor was adequately protected in the event of termination by the contract's termination provisions and that in any additional price-redetermination negotiations the contractor's experienced costs of materials would receive due consideration. Therefore, in our opinion, the possibility of termination or additional price redetermination taking place did not warrant the contractor's overstatement of estimated material costs. With respect to increase in suppliers' firm prices, we believe that suppliers, as well as prime contractors, should generally be expected to live within firm prices. agreed upon, and therefore the prime contractor's estimates of the cost of materials should have been based on known firm prices, with any significant deviations therefrom in the contractor's price proposal clearly set forth for consideration by Air Force negotiators. In April 1956 we brought our findings, including the known reductions of $1,700,000 in subcontractors' prices, to the attention of AMC and General Motors. At a meeting on September 26, 1956, attended by the Deputy Director for Procurement, Directorate of Procurement and Production, Headquarters AMC, and the controller, General Motors Corp., it was suggested that General Motors consider, as a matter of principle, a refund of $1,700,000 to the Air Force. In rejecting this suggestion, General Motors cited a number of reasons why, in their opinion, there was no basis for any misunderstanding of the facts on the part of any of the parties participating in the priceredetermination negotiations. I refer you to appendix C, exhibit D, of our report. Based on the information available to us, including General Motors' comments dated June 18, 1957, on our draft report, there is serious question as to the legal validity of the negotiated prices. In order to resolve this matter, additional information has been requested by the Comptroller General of the United States from the Secretary of the Air Force by letter dated July 8, 1957. This letter is contained as appendix D in our report, Mr. Chairman. With respect to the second element, of direct labor estimates, adequate evaluation of the contractor's direct labor estimate for the first forward price-redetermination period could have resulted in a reduction of approximately $842,000 in the contractor's projection of direct labor. The contractor estimated that 24,697 direct-labor hours would be required for each of the 228 airplanes from No. 72 through 299. On the basis of independent calculations, AMC accepted this estimate as being fairly accurate, but reduced it by 1,500 hours per airplane. We understand that this change was made to reflect efficiencies anticipated |