. I I HOUSEca \/Efi$ggi’i’ (Jp&y?TyJo)JS(j,-]~*~t’:Ip&-~E llIlllllllllllllllllllllllllllllllllllll LM094432 .‘ Nr. Chairman and Kembers of the Subcommittee: Me appear this morning in response Lto your request to discuss 0uT report of March 17, 19'71, entitled "Defense Industry Profit Study.!' It is my tiderstanding tnat your reques t originated at the suggestion of several members of the House of Hepresentativcs to obtain our views with respect to critical comments made by the press, in particular, the alle- gation that GAO had been subjected to pressures from defense contrac+trs and tine defense agencies, and had altered tne facts and conclusions in its report as a result of such pressures. . Wdle I welcome this hearing, I should like to express my regret that a few, *but widely circulated, premature, inacc-urate, and misleading press stories have made this hearing necessary. In my opinion, such re- ports are a disservice to the Office which I head and to tne Congress of which the General Accounting Office is a part. I am pleased that most press accounts, issued following t!e release of tne GAO report, have been generally accurate and objective. In summary, I would like to emphasize these points: 1. It has been the policy of the GAO for many years 'a refer draft reports of Tunis Office to the agencies, organizations, and others speci- fically affected to obtain their views. This is done to enable us to report to the Cclnrr,ess an d thi piblic any disagreements as "to the factual completeness of the roLmrt ae L,,_- Tnl7 as differences with respect to our findings and conciusis~-,s. 2. Not a sir,gle figpe has been altered at any stage in the draft- ing of the reprt on defense ir;dustry profit and none has been added or deleted as a result of agency or contractor views. s* Our conclusion in the report has been unchanged since the original draft was sent to age ncies and industry groups for review, The final re- port is critical of the way in which profit objectives have been established on defense contracts in that profit objectives have been primarily on the basis of cost of sales without adequate consideration of return on capital investmerit, Some contracLmrs agree wiVn our position but many do not, It was primarily to obtain their views on this subject t'nat we asked the agencies and the contractors,t'nrough LnBir associations,to react to OUT report. We believe that the Congress and the public should know that some disagree with our conclusion. 4. Contrary to certain press reports, there was no llpressurell of any type. Neither I nor any member of our staff received any follow-up communications, oral or written, from these associations beyond the formal respnses to our request for their views. At this point, I would like to discuss our plicy of submitting draft reports to agencies and otner affected parties for comments prior to issuance as an official report of the Comptroller General to the Congress. In discussing "inis point, we shall, as you requested, relate -2- draft 0:’ ti;;f. 1 e&.71-t cs;_i?d ‘.jhrdJ 17, 1371, 05 ihe Ddeme Industry Profit s 'iudy * Gj3'rJEfiE:L KJL;CI' ------.. TO bl&l----D.m-l- y:y$; PI&RX_..<& T- f, CF (2-:; ?E!yz, F;<i)M --___ F$mC’T%D PAH;I‘IES The pract4ce of obtsining mmmts fmm sffected parties on proposed audit reports is one of' long standing lrithin tile GAO and it goes even further back in the public accosting prcfession, just how far I do not know. It is interesting to note thst as early as 1935 ihe Congress, in an amendment to the Tennessee Valley Authority Act, specifically prohibited issuance of report s on GAO audits required in the Act -until TVA "shall have had reasonable opportunity to examine the exceptions and criticisms ss+i, to point out errors therein, explain or answer the same, and to file a statement which shall be submitted b37 the kmptroller General rJith his report * If The practice became written policy of t,he Office when.3.t krEls in- . corprated into internal instructions to the Accounting and Auditing staff in 1454. This policy became applicable to contract audit reports in 1955. Prior TV that time it was fairly common practice to obtain oral and some- times written comments from agency officials and contrac"trs on specific matters as tk individual audit manager may have felt it was desirable, Although I can claim no responsibility for instituting such a policy, I examined this policy carefully when I became Comptroller General-in 1966. I endorsed the plicy and have retained it. A review of the auditors' findings and conclusions by tne person or organization on wnose records and operations we are reporting is desirable for a number of reasons. Since our reports deal with highly important -3- . - matters, frequentl;: of nsti~:r:sl sigii;fic;nc51 it IS esselitsai that a 11 the relevant facts be asceri:3in~+S ani that tsiltyj' be pXperly evaluated, In our opinion, ii is premat*;cre to rep2r-i to i;ne Cxigress ow findings, conclusions, and recommendations 0:: 'sr,e basis of inf~~8rxation gatkred at var2.ou3 agency or contractor operating levels Kithout considering any additional pertinent information wZch may only be secured from top agency or contractor officials. Tne practice of obtaining advance comments on drafts of our reports before issuance as final reports and giving objective consideration to t-ho se COIrIIiIents provides additional assurance that our reports are fair, complete and objective. Another very important consideration, it seems "to me, is the fact that obtaining comments and reactions in advance enables us to present t,z ihe Congress in one document tine whole package--the facts as we found them, our conclusions from those facts, ourSrecommendations for corrective action alid. 'ilie head. of the ageacyls position on the‘matter. If a disagree- ment exists between the Comptroller General and the agency head, the report reflects it, and the CommAttee or Member is t'nen in position to evaluate the issues from a study of t'ne document in hand. From time 'L time we will have exceptional sihations in which we find it appropriate Aa proceed without awaiting formal agency comment when formal comments are unreasonably delayed. However, the substance -6f a pro- posed report would in all cases b,0 discussed with top agency officials. In the -unusual cases, when we proceed witnout formal comment, we attempt "a give the agency advance notice and indicate in the reprt why comments have not be received. -L- _.__, Kit:? that backgrotiii; in mind, it should not seem uniusuai or suspect in any way for our proposed fincii~~~gs arid conclusions in the Defense Industry Profit Study +d have been reviewed by the defense contracting agencies and the associations of coni rar+brs ~wrose records provided the basis for those findings and conclusions. In fact, it would seem especially important to do so inasmuch as tine study M, 7 Q of such imDortance that it was directed by an Act of Congress. Therefore, the hignest degree of objectivity, in my view9 was absolutely essential. Let me now discuss that study and re*port specifica .lly. First, the study and its resulis: THE DEFENSE INDUSI'RY PROFIT STUDY During the nearings in November 15@i) and in January 13&j the Suebcom- mittee on Economy in Government of tine Joint Economic Committee developed - ':'-. in considerable detail the need for a comprehensive study of profits realized by defense contractors. Subsequently, .-the Armed Forces Appropria- tion kinorizaiion Act for fiscal year l$'O, P-ublic Law 91-121, approved November 19, 1959, directed GAO to study profits earned on negotiated contracts and subcontracts entered into by tne Department of Defense, I Wtional Aeronautics and Space Administration, and the Coast Guard, Con- I5 tracts of tne Atomic Energy Commission awArded to meet requirements-of the _ , Department of Defense were also included. In responding "tx3 the mandat e of t‘ne Gongress in that Act, we requested annual overall proii' L, data from 154 contractors through t‘ne use of ques- tionnaires. -j- tnro-dgh 1963 00 sales, profits, total capital ir~vepLmen?J, aid p---I .__,: tra pt,-, r equity investmenT for defense business azi~ corn. _. .,!c co ml;.c-r' C'i 111 s '- -15s . The I5L ColitrZCAd3TS inci&ed 21 large D@D co,;:t~c~~rs, 63 mkiller* defer1ce conirac-tars 9 a:6 10 cont~dc"~rs who received a major p3~-%ion of their defense business in tne form of subcontract awards. We worked closely with the contra lors in explaining ihe questionnaire and in assisting any contractor needing help. As a result, we obtained data from ail of the contractors except 2 that had gone out of business. The contractors that furnished data accounted for (1) about 60 percent of recen; COD prime con- tract awards of $lcl,OOO or more, (2j about 80 percent of similar NASA contract awards, aXi (jj a significant part of AEC and Coast Guard con- tract awards, Upon receiving informatior zr"c'u,;L Yne*use of questionnairep we de- voted considerable effort to testing and evaluating tne data. We selected 40 of the 152 completed questionnaires for site verification, and carefully reviewed the remaining 112 questionnaires. As a result of this review we made visits to additional contra&ors as we deemed necessary for checking any apparently questionable data. We did not, of course, completely verify all ihe data because it was not practicable to do so, We did the work we considered reasonable in the circumstances. In this conneciion we made use of the contractors' financial statements which had been audited by their certified public accountants. As a resuit of our 40 site reviews and careful checking of tine remain- ing 112 questionnaires the profit data was revised to some extent. As an -6- i:-,a_7,;ylj:,,-d vf ;,i-;F c2XSe.v ;, j; ‘;I,? Ar<?, tr.c2 : s”ui,.;‘:, c’:-t 1 ;.r_7 ,~:‘i_ : i!_l irlve ~,-~IT,-T’;I ~ (yci j q.:;islp& 2~ i'oilok.3: /: 0 qcr-;- ---j r: :,I 13-i -ez T'"'Ij "l,.'.f.Z- 5'.IL------ Z!? ss ter ;!et;:rn on TCI for KID wc~rk increasecl 1.2 percer,L from 9:, $3 13.9 percD:Lt~ 8 12.4 percer,t lncrezse. -&tfxj-~ c::! '2~:: :':7r c:7pfl‘:r:iei kT;r!c ,?e-- creased 6.4 percent from 13.6 to 13.2 perce!:t, a ue,:rease of 2.9 percent. 212 Questionnaires reirieVe5 -------A. laI~?eLy in ---- 122S!!iil~tOll Return on 'ICI for DOD work increased 9.5 percent from 10.3 A& 1ti.S; percent, an increase of 4.9 percerlt. Return on TCI for commercial work decreased 5.1 perce::t from 13.4 tc3 13.3 perceriii, a decresse of 0.7 percent. Review of Individual ---- Defense Coniracis In reviewing hearings of the Joint Economic Committee lhlhich ied to this study, we noted some concern r&t contractor capital requirements were not considered in negotiating defense contract prices. Although not called for specifically in tne legislation, we decided to attempt ix determine whether it was practical to develop investment data by contra. -t and to see if there was a tide range in profits as a percent of invested capital. By our examination we found that it was feasible Lo develop invested capital data by contract and we believe that ii is feasible 'to forecast similar -_ data for use in negotiating defense contreats. Further, as stated in our re- port, we believe that the wide range in rates of return on cspital used for defense contracts is due in som3 degree ho &he fact that, under present pal- i&es, Government procurement personnel give little consideration to contrac- tors' capital requirements in developing profit rate objectives for negotiated contracts. Instead, profit objectives are developed as a percentage of the -?- anticipated cost of material, labor and overhetd, A.s a result, jnccpities can and do arise'among contractors providing differing i;rcportions of the capital required for contract performance, Also, by relating profits to costs, contractirs have little incentive "a make imestmnts in ecpipment which would increase efficiency and reduce costs, Such invest-Gents tend to lower rather than increase profits in the long run, Of course, other fxtors, such as whether or not the program will be continued, could be an overriding consideration in bringing about contractor investments to reduce costs. We believe that of the various ratios available for evaluating profits earned by contractors, the percentage of profit earned on total capital in- vestment--the total investment in all assets used in the business, exclusive of any Government-owned items or leased items--is the most meaningful for evaluating defense profits. The rate of return on total capital investment relates earnings to total capital employed, regardless of whether it vas pro- vided by the owners of a business, its creditors, or its suppliers. Since interest is not an allowable cost under Government contracts and must be paid out of profits, it seems only equitable to consider total capital in determining profits. With respect to the individual contract data, as in the case of the questionnaire data, the information was taken from the contractors'books and -_ records. We did the verification work we thought necessary in the circum- stances and we believe ,that the data is reasonably accurate. None of the data has been subject to detailed audit in the sense of tracing cost from indi- vidual source documents, such as invoices and payroll records, to the con- tractors' records. In each case we presented our data to the contractors involved for review and comment. We carefully considered the comments re- ceived and there were relatively few cases involving disagreements. impracticable to e:ttemst tc ob.-airi a sample that would support a pro;ection of t:c.e res:;its to ail. defense contracts. Some exarqles of j~he 7~arja-r Lev- t:--~+ ..xd cake such a projection impracticable are as follo%Y3: 1, ideztificatloz.1 of t'ne SJlrliverse of completed contracts was not available. This would have had to be developed by querying all of the cczzpanies involved, 2. There 'Kere several types of negotiated contracts represented, 5ncludi_ng cost plus fixed fee, cost plus incentive fee, fixed price Sncentive, and firm fixed price. 3. Ecmerous product classes were involved, including aircraft, missile-space, ships, tank-automotive, weapons, azrmunition, electronics, comzunications , and many others. 4. Four agencies had to be covered - DOD, %%A., AEC and Cqast Guard. Considering the above variables plus (1) the need for information as to the statm of production involved, and (2) the fact that there are about 180,000 annual DOD contract actions of $10,000 or more, the sample size required for making a reasonabl;r accurate projection as to the entire universe was prohibitive, Nevertheless, we thought that it was desirable to review some contracts and since a representative sample was prohibi- tive, we selected some contracts for review based on availability of manpower in our regions. In summary of our discussion on this point, it would be misleading to generalize on overall defense contracts from the individual contract -9- data. Ti:e qz2sticncaire data covered $125 billion in defense sales Vnile OCR indivi,iua!, contract data accounted for onl:q $4,3 billicn over approximatel:~ the same period. The questionnaire data, therefore, pro-vide 6 a bztter anti more reliable basis for reflecting defense industry prof-its* Preparation -. ---Iof the Final Report I would n@:r like to discuss briefly some of the changes made in our report on Defense profits after it was issued in draft form for comment by those concerned. In our consideration here of these changes, I believe tde should primarily concern outselves with whether the changes tiproved the report in terms of balance, objectivity, fairness, and completeness, Much has been said about the placement in the report of the section dealing with our review of individual contracts. ‘The facts are these. It was decided at the very outset of our work that the only practical way of meeting the requirements of the law was by the use of the question- naire in developing data on the overall profitability of defense work. Our work on individual contracts was completed and the results were written up in draft form first. Tbls section appeared in our draft first since it was the most complete at that time, not because we con- sidered it the most significant portion of our work. When the report draft was released for comments, our analysis azd verification work on the questionnaire data had not yet been completed and the results were tentative only. In the final report, we believed ' it only logical that the portion of our report which we concluded to - 10 - be responsive to the statutory directive be discussed first. We then bring 5n the individ>Jal contract data in developing our point that contrac-iiors f invested capital should be given greater emphasis in negotiating defense contracts. Further, we do not believe there is a problem of subordination of points in this report involving oril) 55 pages and containing a summary of four and one-half pages. In developing the final report we decided to have a single conclu- sions section. We also deleted from the conclusions section information concerning benefits to contractos attributable to defense work since benefits also flow to defense work from com~~ercial work of defense con- tractors. We had not developed ~cifically in our review the extent of such benefits and whether there was a preponderance of benefits to co111- mercial or defense stork. Further, we had not been asked to evaluate defense profits in terms of whether they were too high or too low, Our purpose was simply to find out what the profits were, There are numerous changes in wording between the draft and final repoti. This occurs in almost every report we issue. Our review processes require consideration of our reports by our Office of Policy and Special Studies and by our Office of General Counsel, as well as by report reviewers in our operating Divisions responsible for the assignment. Sometimes changes are made at meetings of two or more of these review groups. I believe it is reasonable to think that many of editorial changes involved in the report would have taken place even if we hadn't received agency or contractor comments. For example, one change we made in word- ing was made regarding consideration of return on investment in developing - 11 - profit objectives in price negotiations. In our final report we added thas risk complexity and other factors should also continue to receive consideration. Some n;ay consider this a softening of our position; we do not agree. It is simply reflective of our conclu sion that the return on investment cannot be the only criterion, I would like to emphasize that there was no softening of the report as a result of obtaining comments on the rough draft. One colwr;nist reported that we had weakened the report by eliminating a phrase in our recommendation that profit guidelines %ressV return on capital in determining profits. Actually in the recmmendation in the final report it is stated that the profit guidelines should "emphasize" consideration of the total amount of contractor capital required. We . think the final wording is just as strong if not stronger than the original wording. RELEASE a------- OF SPECIAL GAO REPORTS Now, Mr. Chairman, you have asked that we discuss the point concerning our policy with regard to the release by GAO--or non-release--of reports made to Committees or individual Members at their request, It has been the policy in the General Accounting Office as far back as anyone in our Office knows to accord to the requesting Member or Committee Chairman complete control over the report he receives. Without his approval or unless he himself makes public the contents, we do not consider it proper to release copies to any one else. I think co*urtesy demands this kind of treatment, - 12 - . . That is not to sa!;, however, that a ?I&ber could effectively Yock up " infomation OT, m-y certain matter by skply requesting GAC to review it and report to him,. We would most certainly honor the suze request fro;-, other members and we would, if necessary, I:.al:e a similar report to other requesting members at the same time, regardLess of the relative timing of the requests, NOrrr,all;.~, an accor.odation can be arranged so that one report, with copies available to other interested members, will suffice, eliminating the time and expense of separately addressed reports. However, if necessary, making similar reports simuI.taneously to more than one member is a small price to pay for harmony e In practice, problems in this respect arise only infrequently. One may question--the more basic policy of honoring requests at all from individual Members of Congress for reviews, audits, or investi- gations of specific subjects. The law does not expressly require it but, to the extent that available resources permit, the Office has always, so far as I can learn, followed the policy of complying with all reasonable requests for such assistance by Jilembers. &.ny times, in so doing, we find situations which need correcting and some which indicate a more general problem needing attention. Instances of bad management or poor controls are sometimes brought to light wi,ich we might not have discovered but for the request. We are told frequently by Members that they consider the General Accounting Office as the only independent and objective source available - 13 - . ,. to t:,e~! for is.foxztion regarding p:-cgm~ operaticns in the Executi.ve Branch. Of course, we do not as a mtter of policy a~to~atically accede to every request we receive. Tine custoxar:,; practice is to discuss with the requesting Mexber or Comittee at the very outset just what we may be able to do in a given situation and, if necessary, insist on cor.fining the job to mmageable and reasonable boundaries, AlSO, we wo,tid not undertake reviews outside our nonmal jurisdication such as one designed to reflect upon a potential political opponent, for exsxple. We would not undertake purely criminal. type investigations since these should be handled by appropriate law enforcement agencies. When a review or investigation requested specially by an individual results in significant findings which we know should be of broad interest, we take the initiative in attempting to arrange for wider distribution of the information. We may arrange with the requester for us to address the report to Congress or, failing that, we would urge the Mexnber to either make the wider distribution himself or permit us to do it. I know of no significant case in which we have been unable to obtain wider distribution when we considered it ;Important to do so. IQ-. Chairn;an, with regard to special requests and special reports, I think it is pertinent to note the cements of the House Committee on Rules in its report on xI,R, 17654, which was enacted as the Legislative Reorganization Act of 1970. In discussing the provisions of the bill -u- :- The report states at page 13: “The Cc3mptroUcr Genes21 mst exercise some discretion in deciding %%a-&constitutes a ‘report 0 ’ Tnere are -Limes when the Cozplxolld-er ClneraX and a Hember or comittee of Congress have a confidential. relationship such as might exist betxeen an attorney or an accoun-&n-t and his clien.t, Committee frequently ask the Coxptxoller General.. for info-d-lria-ixion to be used during commit’cee hearings in the examination of witnesses o It would clearly be unwise Lo reauire the Comptroller General to make the contents of thise reports avaiILab2.e on request in advance of their intended use D” Mr, Chairman, this comp-letes my prepared s”ca’cemen’c. I@ associates and f: vi%% be happy to respxd Lo any questions you Mary have. - 15 -
Defense Industry Profit Study
Published by the Government Accountability Office on 1971-03-26.
Below is a raw (and likely hideous) rendition of the original report. (PDF)