APPENDIX 1E-MEMORANDUM ON REVIEW OF REPORTS BY OFFICE OF GENERAL COUNSEL, GAO U.S. GENERAL ACCOUNTING OFFICE, OFFICE OF GENERAL COUNSEL, Washington, D.C., December 21, 1959. Memorandum to all attorneys and reviewers: It is my understanding there is some question as to the areas to be covered in our reviews of draft audit reports. Our review should be directed primarily to two areas. They are legal matters and congressional matters. In addition, we should feel free to offer comments and suggestions on other matters with respect to which we think a change in the report will result in significant improvement. LEGAL MATTERS We have specific responsibility for examining all legal matters pertaining to the draft report. This responsibility includes consideration of the legal points covered in the report, as well as legal aspects not specifically covered. For example, if a draft report proposes only to criticize the method of contracting used and, upon review, we are of the opinion that improper payments have been made as a result of the method of contracting or for any other reason, we should so state in our comments on the draft report. CONGRESSIONAL MATTERS Review of draft reports should also include consideration of any congressional implications contained in the report. Attorneys who are assigned draft reports for review should take note of any congressional implications which may be involved and discuss the report with the appropriate staff member of the Office of Legislative Liaison. See Comptroller General Order 1.4, October 15, 1959, paragraph 11. Examples of the types of reports which should be discussed: 1. Reports which are being furnished upon request of a committee or a Member of Congress. 2. Reports which contain legislative recommendations. 3. Reports which contain references to committees or individual Members of Congress. 4. Reports in which the agency comments indicate that Congress has been made aware of a matter covered in the report. 5. Reports in which access to agency records is discussed. OTHER As indicated above, in our review of draft reports we should feel free to offer comments and suggestions on other matters with respect to which we think some appropriate change will result in significant improvement, even though the suggestions are in an area other than that in which we have a specific responsibility. Of course, responsibility for the acceptance or rejection of such suggestions rests with the Accounting and Auditing Divisions. In making such suggestions, be certain they are significant. Also, the suggestions should be identified separately in the memorandums to the Accounting and Auditing Divisions. ROBERT F. KELLER, General Counsel. APPENDIX 1F-TRANSMITTAL LETTER FROM GAO REPORT B-146718 GENERAL STATES TED STA B-146718 COMPTROLLER GENERAL OF THE UNITED STATES WASHINGTON, D.C. 20548 JEG 11 96 To the Speaker of the House of Representatives In March 1964 we reported to the Congress that the Department of the Navy had contracted to pay Bethlehem Steel Company, Shipbuilding Division, Quincy, Massachusetts, about $5 million more for the construction of the nuclear frigate, U.S.S. BAINBRIDGE, than was warranted on the basis of available cost data and the circumstances existing at the time of negotiations. The circumstances follow. The U.S.S. BAINBRIDGE was started under a letter of intent to contract, commonly called a letter contract, which provided that construction work begin promptly but that the price be negotiated later. During the first three quarters of the construction period, the Navy made repeated attempts to negotiate a reasonable price including terms which would have protected Bethlehem against unexpected cost increases but would not have paid Bethlehem for such increases if they were not incurred. Bethlehem, however, rejected all offers by Navy contracting personnel. After about 75 percent of the construction work had been completed, negotiations culminated in the tentative acceptance of a price of $87 million by the Bureau of Ships. This agreement was tentative because all sizable Navy contracts must be approved by the Office of Naval Material before they become binding upon the Government, Accordingly, the Bureau of Ships recommended to the Office of Naval Material that it approve the contract at a fixed price of $87 million. Representatives of that Office reached the conclusion that the price was too high and suggested an alternative. However, the alternative was refused by Bethlehem which adamantly rejected any terms other than a fixed price of $87 million. The Office of Naval Material was unwilling to approve acceptance of this price and referred the matter for decision to Mr. Kenneth E. BeLieu, Assistant Secretary of the Navy (Installations and Logistics). Navy files disclosed that Mr. BeLieu verbally approved acceptance of the fixed price of $87 million. A fixed-price contract in that amount was awarded to Bethlehem on January 11, 1962. Subsequently, we reviewed Bethlehem's statement of costs--totaling $82 million--and identified substantial contingencies and allowances for costs not properly chargeable to contract NObs-4239 that had been included in Bethlehem's cost statement. In this respect we found that Bethlehem's statement of actual and estimated costs included a provision for contingencies of about $3.4 million and duplications and overstatements of costs totaling about $1.6 million including (1) costs for change orders that were to be priced separately, (2) excessive charges for overhead costs, and (3) overstatement of material costs. Analysis of these estimates and related data disclosed that, if Bethlehem completed the last 25 percent of the ship with a level of performance commensurate with that applicable to the first 75 percent of the ship, it would be likely to incur costs of about $77 million, or $5 million less than indicated by the total of its cost statement. Accordingly, we recommended that the Secretary of Defense take all action available to him to obtain a price adjustment from the Bethlehem Steel Company for the overpricing of $5 million. We recommended also that the Secretary of Defense establish regulations to require that, if work is more than half completed under a letter of intent, a fixed price contract will not be used unless it can be affirmatively established that it is in the Government's interest to put the contract on a fixed-price basis and that the use of a fixed price be approved by the Secretary of Defense. The Department replied to our report by letter of June 1, 1964, from the Deputy Assistant Secretary of Defense (Procurement). Although the Department does not assert that the price negotiated with Bethlehem was reasonable, it does not propose to attempt recovery of $5 million, the amount of overpricing disclosed by our review. The Department bases its position on its policy that adjustment of contract prices should not be sought unless there is a legal basis or unless the contractor has made misrepresentations which misled the Government negotiators. The Department also does not plan to establish any special regulations governing the conversion of letters of intent to fixed-price contracts. Instead, the Department proposes to reduce the instances in which letter contracts will be used. The Department has defended its action primarily on the basis that a fixed price is preferable to the continuation of cost-reimbursable arrangements under letter contracts because of the built-in motivation to stretch out the work under a letter contract. The Department indicated that it knew of no reason to assume that this motivation could be controlled by Government monitoring of costs. We concur in the Department's views that letter contracts should be avoided whenever possible; however, pending their complete elimination, we believe that the Department should be prepared to deal with them. Further, similar situations arise in connection with cost-type contracts of which the Department of Defense has large numbers. In this respect, we previously reported a similar case involving a costtype contract with Brown-Raymond-Walsh for construction of military bases in Spain. In this case, conversion of a portion of the contract to a fixed-price basis after most of the work had been completed under a cost-reimbursable arrangement resulted in millions of dollars of additional costs to the Government. Therefore, after giving careful consideration to the Department's views, we conclude that further action is warranted in this case and are making the following recommendations: 1. We are recommending that the Secretary of Defense reconsider the application of Department of Defense policy to this case and seek appropriate recovery from Bethlehem, because Bethlehem contributed to the overpricing of contract NObs4239 by submitting a proposal containing duplications, overstatements, and unidentified contingencies of substantial amount. 2. We are recommending also that the Secretary of Defense take action to assure that Bethlehem's actions in this case receive appropriate consideration by Government procurement officers in the award and administration of any subsequent contracts. 3. In view of the substantial pricing penalty accepted by the Navy to extricate itself from the cost-reimbursable arrangement with Bethlehem in this case and with Brown-Raymond-Walsh under the Spanish base construction program, we are recommending that the Secretary of Defense direct that reexamination be made of the administrative controls over costs being incurred under cost-reimbursable contracts and take such steps as are needed to make its controls adequate to assure reasonable economy and efficiency to the Government in the performance of cost-reimbursable contracts. Such controls are needed because of the use of cost-reimbursable-type contracts by the Navy as a suitable arrangement for procurements where cost data is lacking and production costs cannot be forecast with sufficient accuracy to provide a reasonable basis for firmer pricing arrangements. Copies of this report are being sent to the President of the United States, the Secretary of Defense, and the Secretary of the Navy. Hraph Campbell Comptroller General of the United States |