CONTRACT TERMS

The CHAIRMAN. Now we come to contract terms. The Comptroller General said that frequent failures on the part of both prime contractors and agency officials to get accurate cost data to justify the price quoted by the subcontractor, that in many cases the prime contractors merely took the estimates of the subcontractor without justifying them and that they were made in advance of any experience, and that these excessive subcontract cost estimates resulted in excessive prime contract prices and unwarranted profit to the prime contractor since the prime contractor generally also receives profit on the subcontractor's charges and in situations of this nature the prime contractor is rewarded for his inefficiency.

Mr. MCGUIRE. I think the conclusion that the Comptroller General, took is correct in this respect.

It is regrettable that this situation was allowed to happen.

I think the Comptroller General also pointed out, if I understand his remarks, that in this particular field of procurement that we have worked closely with him and tightened this thing up.

I think the cases referred to, and I do not mean this as a defense, are cases of the past, earlier than 1958. Some of these contracts are continuing so I am not going to say this could not be happening today. I think we send a copy of every contract we make to the Comptroller General, as you know.

He has investigated a large number of contracts in the last 2 years. He has about a hundred men working on it. I think he has reported to Congress some 35 of these contracts. These have been very helpful where he has pointed out necessary corrections.

What I am trying to say is that I do not agree that this is indicative of the way we do contracting in every contract.

Senator O'MAHONEY. What authority do you have to tighten them up?

Mr. MCGUIRE. In this field, I have all the authority anybody could ask for. There is no question of lack of authority.

The Secretary of Defense has delegated in me the authority to issue ASPR. This is one of the very clean-cut delegations of authority at my level. I have no argument from the services on that. They accept it. Those of us who have been in the ASPR field have a good working relationship here.

One of the things we did as a result of this business of costs that were part of cost estimates not being current, is to make it mandatory that the contractor certify they are current.

Now, he is in a very embarrassing position if they are not, because he is using this certification as part of the entering of a Government

contract.

My position on this matter is that some of these contractors by the very magnitude of the procurement we are involved in are in reality agents of the Government and this cannot be a game of hide and seek. This negotiation must be a mutually helpful one on both sides. We don't want the contractor to lose money. We don't want him to make too much, either.

Mr. BANNERMAN. On this subject of contracting you have just asked about, we have recently issued-and I think the General Accounting Office was helpful to us in getting this out-a rather substantial revision to our Armed Services Procurement Regulation requiring a far greater review and expanded cost analysis on subcontracting.

This was done on 1 October 1959.

Mr. MCGUIRE. We will be glad to supply you a copy of this although I think maybe your staff has it.

(See pp. 357-361.)

Mr. BANNERMAN. Actually, Mr. Campbell commented on this favorably in his report yesterday.

INSURANCE ON GOVERNMENT-OWNED PROPERTY

The CHAIRMAN. Now, the Comptroller General says that in some cases your require contractors using Government-owned property to carry insurance on that Government-owned property which was then charged in the contract price although the general policy throughout the Government is one of self-insurance.

Mr. MCGUIRE. We issued a regulation on this on the 18th of September, 1958, through ASPR, and I believe this was as a result of some work with the Comptroller General.

Details of this I will let Mr. Bannerman explain but in essence it is this:

If we have a Government-owned facility and 75 percent of the work in this facility is for the Government, we become the self-insurers. If the reverse position is true, the manufacturer becomes the insurer. Mr. BANNERMAN. Actually, the cases involved are very old contracts long before this policy evolved.

RENT FREE USE OF GOVERNMENT PROPERTY

The CHAIRMAN. Now, the Comptroller General charges that in certain cases contractors use Government-owned facilities without paying rent for them. In one case this went on for 8 years.

What is the reply to that?

Mr. BANNERMAN. Since June of 1959, we have had the fixed policy in the Department of Defense not to lease industrial facilities for commercial use without the payment of rent.

As you pointed out, this contract we are talking about goes clear back to Korean war days.

I think there was in that case an agreement that rent was due, but there was a failure to administer the contract in such a way as to collect it. The amount due was in dispute.

The CHAIRMAN. Is this a unique case?

Mr. BANNERMAN. It was unique, Mr. Chairman.

Mr. MCGUIRE. I don't know the details, but I would prefer to say this particular case was unique. There may be others in the sume area that might have a bearing on this.

Mr. BANNERMAN. This was the only one of this kind reported by Mr. Campbell.

WAREHOUSE SPACE RENTAL RATES

The CHAIRMAN. May I ask this: You have warehouse facilities. Do you charge the private firms to whom you rent out warehousing facilities the same rate that you charge General Services Administration for its stockpile and other items.

Mr. RILEY. I am pretty sure that we have a common reimbursable policy whether we rent to private industry or within the military service.

It is the going commercial rate in that particular area.

Mr. MCGUIRE. Are you talking about the going rate of commercial enterprise in the area? Is this going rate higher than the standard Government interchange rate? Do we charge the commercial people more or the same price?

Mr. CAPUTO. More.

For example, in the New York City area

The CHAIRMAN. I did not catch the reply.

Mr. CAPUTO. For example, in the New York City area warehouse space goes about $1.20 a square foot. If we have space available to rent commercially we get the $1.20 rate even if it cost the Government

35 cents.

The CHAIRMAN. What would your rates be to General Services Administration?

Mr. CAPUTO. To General Services Administration it is 35 cents. We have a prescribed rate to General Services Administration of 35

cents.

The CHAIRMAN. Thank you.

RECOMMENDATION FOR A SINGLE AUDIT AGENCY

Representative CURTIS. On this subject that the Senator is pursuing about GAO's comments there is one I want to pick up. I believe last year the Assistant Secretary of Defense, because of certain GAO criticism, appointed representatives from three of the country's largest accounting firms to survey the internal audit function carried on by the Army, Navy, and Air Force, and they made their recommendations on November 28, which was that there should be a single auditing agency.

As far as the committee has been able to determine the Department of Defense has not yet taken an official position on this recommendation.

I wonder what the status is.

Mr. MCGUIRE. I cannot speak with authority. I think you know, Mr. Congressman, it was in Mr. McNeil's area. I am very anxious also

Representative CURTIS. Wait. Let me get that. That was in Mr. McNeil's area. How is that related? How do you relate your area and his area in auditing?

Mr. MCGUIRE. In the auditing area we get auditing reports through

the services.

The contract audit areas have always been within Mr. McNeil's shop.

Now, I understand about this report. I don't have the responsibility for this function. I have an interest in it.

I have not heard the final conclusion on this matter. We have a man from his shop here as a backup witness if you care to call on him.

Representative CURTIS. Let me ask this as far as your shop is concerned. Would this not help your organization if this would get you better information and material?

Mr. MCGUIRE. There are two sides to this question. At the moment we are getting good audit service. That does not mean it cannot be improved.

There is a long story. We get it in business-the procurement officer versus the audit officer. Who is the final determiner of different opinions?

With a standard set of cost principles out, I have a feeling that there is a possibility we might get some more benefits out of a single audit agency now. It is the feeling on my part and I must be fair about it. I cannot in good sense justify this feeling, but I intend to keep raising the possibilities of it because I think it is worthwhile exploring.

I am not sure we are ready for it yet, but it is certainly something

DELAY IN MAKING DECISIONS

Representative CURTIS. It seems to me that the GAO criticism was well founded and certainly the three top auditing firms of this country that were used concluded that way.

This is dated November 19, 1958. That is the thing that is so disturbing to me. Over 14 months have elapsed and no action.

Mr. MCGUIRE. When I return to the department I shall be glad to give your question to Mr. Lincoln who has now succeeded Mr. McNeil and ask him to supply an answer for the record. I am sure that is one form of pressure.

(The material referred to follows:)

Hon. PAUL H. DOUGLAS,

ASSISTANT SECRETARY OF DEFENSE,

COMPTROLLER,

Washington, D.C., February 24, 1960.

Chairman of the Subcommittee on Defense Procurement,
Joint Economic Committee, U.S. Senate.

DEAR MR. CHAIRMAN: When Mr. McGuire testified before the Joint Economic Committee on January 29, 1960, he was asked the status of a recommendation by outside consultants to establish a single auditing agency. This question was referred to the Assistant Secretary of Defense (Comptroller) for response.

This recommendation has been the subject of considerable study. There are serious disadvantages as well as advantages which might follow adoption of the recommendation. Although no final determination has been made of the Department of Defense official position on this recommendation, there is attached hereto a statement concerning the problems related to the recommendation and the advantages and disadvantages which might follow.

Sincerely,

JOHN M. SPRAGUE, Deputy Assistant Secretary of Defense.

STATUS OF RECOMMENDATION FOR A SINGLE CONTRACT-AUDIT AGENCY This is an answer to a question by a member of the Joint Economic Committee, Representative Curtis, with respect to the status of the Department of Defense concerning the recommendation made by outside accountant-consultants that there should be a single contract audit agency rather than separate contract

audit functions in the three military departments. This recommendation did not go so far as to propose merger of all audit functions, as suggested by the question asked.

By contract auditing is meant the audit service provided to procurement officials of the military departments in connection with the pricing of negotiated fixed-price contracts, as well as in allowance of costs under cost-reimbursementtype contracts. Auditing of contractors' records is performed with respect to validity of their cost representations. A large proportion of negotiated fixedprice contracts contain price-revision clauses. These contracts require examination of contractors' costs-not only at the outset as a basis for establishment of initial prices and cost targets, but also upon completion of contracts, or after a substantial portion of the contracts have been completed when price redetermination is required during the course of performance.

Contract auditing is only a part of the total audit function performed by a central audit organization in each of the three military departments. The other audit function is internal auditing, or the internal review and examination of operations within the military departments from the standpoint of their financial and business aspects. This is in contrast to the type of examinations required by the Inspector General organization covering the military aspects of operations. Internal auditing is a kind of policing function in contrast to the service function of contract auditing; this distinction is important in evaluating the proposal for centralization of the contract-audit service in a single agency under the Office of the Secretary of Defense remote from the procurement officials who are located in the bureaus of the Navy, technical services of the Army, and the procurement offices of the Air Materiel Command.

The outside consultants who made the recommendation for centralization of contract auditing were retained by the Assistant Secretary of Defense (Comptroller) to review the military departments' contract-audit operations, to evaluate quality of audits, to indicate differences in approach, and to make suggestions for improvement.

The recommendation submitted for centralization has merit from the standpoint of the professional character of the contract-audit work performed, but, in the opinion of this office, it was not based upon full appreciation of the necessity for performing an adequate procurement service by having a contract auditor who reviews a contractor's price proposal, cost analysis, or claim for cost allowances, act as a service member of a team in which the procurement officer is the chief and responsible for making determinations, including the establishment of prices by negotiation with the contractors.

The Department of Defense has not yet taken an official position on the recommendation for centralization. However, the staff of the Assistant Secretary of Defense (Comptroller) has studied the recommendation, especially with respect to its impact upon the three services in the northeastern section of the United States from the standpoint of costs that might be saved by merger of the three contract audit agencies. Moreover, there have been discussions with the principal officers of the audit agencies and procurement officials in the three military departments. As a result of these studies and discussions certain conclusions have been reached and recommendations made to the Assistant Secretary of Defense (Comptroller) by his principal advisers. The principal conclusions and recommendations may be summarized as follows: (1) There is no question but that a single contract-audit organization might be able to do a better job professionally than the three separate audit agencies. It would be possible to have better training and to indoctrinate personnel in the field so that there would be a single approach to all audit problems. However, in this respect the present situation should not be exaggerated. For example, through the efforts of the Office of the Assistant Secretary of Defense (Comptroller) there exists one "Contract Audit Manual" and a series of joint proce dures letters issued by the Chiefs of the three audit agencies which go almost all the way toward establishment of uniform audit procedures.

(2) A major problem in nonuniformity of procedures is the existence of different procurement procedures in the three military departments, and this could not be corrected through the creation of a single contract-audit agency. Such an agency would be required to observe the individual procedures of each military department and in some cases each separate technical service of the Army or bureau of the Navy, in the same manner as required at present where one contract auditor in a plant services procurement officials of all three military departments.