Department of Energy: Subcontracting Practices

Published by the Government Accountability Office on 1997-11-24.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

  Resources, Community,   and
  Economic Development    Division


  November 24, I997

  The Honorable Ron Wyden
  United States Senate

  Subject: Department of Energy: Subcontracting Practices

  Dear Senator Wyden:

  This report responds to several questions you had regarding subcontract
  oversight practices used by the Department of Energy (DOE). DOE
  accomplishes much of its work by contracting with private companies,
_ and these companies in turn often subcontract many of the tasks to other
  companies. Your questions stem from a subcontract for cleaning up a
  radioactive waste dump called Pit 9 at DOE’s Idaho Falls site, which we
  previously reported was a failure.’ The project was behind schedule and
  over budget and could not be completed either within the established time
  frame or the original subcontract price. DOE and the contractors blamed
  each other for the problems. The uhimate cost to DOE for the project is
  still unclear because DOE and the contractors have not reached
  agreement on how to proceed witi the project.

  As a resuk of these problems, you raised concerns about DOE’s
  subcontract oversight practices in general, as well as how these practices
  were reflected in the Pit 9 project. The Pit 9 project involves two
  companies, or “corporate af%liates,” that are part of Lockheed Martin.
  One company, Lockheed Martin Idaho Technologies Company, has a
  direct (prime) contract with DOE to manage and operate the entire Idaho
  Falls site. The other company, Lockheed Martin Advanced Environmental

  ‘Nuclear Waste: Deuartment of Enere[v’s Proiect to Clean UD Pit 9 at
  Idaho Falls Is Exneriencing Problems (GAO/RCED-97-180, July 28, 1997);
  Nuclear Waste: Detxrrtment of Ener&s pit 9 Cleanup Proiect Is
  Exneriencing Problems (GAO/T-RCED-97-221, July 28, 1997).
                                     GAO/RCED9830R   DOE’s Subcontracting   Practices
B-278476                                                  -
Systems, has a subcontract with Lockheed Martin Idaho Technologies
Company to clean up the wastes in Pit 9. In its role as-management and
operating contractor for the Idaho Falls site, Lockheed Martin Idaho
Technologies Company is responsible for administering the subcontract
with Lockheed MarUn Advanced Environmental Systems. As agreed with
your office, this report discusses whether DOE has policies or contract
requirements that (1) limit subcontracting between corporate affiliates or
limit the amount a subcontractorcan charge for profit when it contracts
with a corporate affiliate and (2) ensure that contractors and
subcontractors make payments they owe to suppliers or other companies
supporting their work.

In summary, we found the following:

In certain instances federal and DOE procurement regulations place limits
on subcontracting between a DOE contractor and its corporate affiliates.
The nature of DOE’s controls over these transactions between corporate
affiliates depends on the type of contract that exists between DOE and
the prime contractor. If DOE has a cost-reimbursement contract with the
prime contractor under which the contractor generally is paid for aII costs
incurred, the regulations generally (1) require that DOE have approval
authority over transactions between corporate aftiliates and (2) prohibit
amounts for profit that can be charged on such transactions if the
contractor and subcontractor have the same corporate mation.
However, if DOE has a fixed-price contract with the prime contractor
under which the contractor is paid a fixed amount regardless of the
 contractor’s costs for doing the work, the regulations do not eaU for
 imposing such controls on subcontracts. Controls are not applied under
 tied-price contra<ts because, unlike under cost-reimbursement
 arrangements, the overah costs to the government are not affected. In the
 case of the Pit 9 project, even though the prime contract was a cost-
 reimbursement contract, DOE ahowed the subcontractor to include an
 amount for profit. DOE did so because at the time the Pit 9
 subcontractor was initially selected, the management and operating
 contract for the Idaho Falls site was held by EG&G Idaho, a company that
 was not a corporate aBiliate of Lockheed Martin Advanced Environmental

While DOE expects its contractors to conduct business in a responsible
manner, it generally lacks the authority to require contractors or their
subcontractors to make payments to suppliers or other companies
supporting the work. An exception exists for certain federal construction

 2                                GAO/WED-98-30R   DOE’s Subcontracting   Practices
B-278476                                                    -
project contracts, for which federal law requires, among other things, that
the contractor post a payment bond to better ensure that suppliers receive
payments owed to them. In the case of the Pit 9 project, DOE determined.
that the project was not a federal construction project because a private
company would own and operate the facilities. Therefore, DOE did not
require a payment bond. A supplier subsequently complained about not
being paid by Lockheed Martin Advanced Environmental Systems for
proposed design work on an analytical laboratory. DOE examined the
complaint, in keeping with its general practice of loo-g into ahegations
that contiactors are not performing responsibly, and determined that the
complaint was not valid because no contractual arrangement existed
between the two companies.


Cleaning up facilities that over the past 50 years have produced the
nation’s supply of nuclear materials for weapons is an enormous and
complex task. This effort is being performed primarily by contractors that
manage and operate many of DOE’s sites, generally under cost-
reimbursement contracts. Under such a contracting arrangement, these
“M&O contractors” are paid for all costs they incur to the extent that the
costs are allowable under the contract. However, primarily in an attempt
to reduce its cleanup costs, in certain instances DOE has used fixed-price
contracts to purchase specific waste cleanup services. These tixed-price
contracts are generally managed either by the M&O contractors or by
DOE directly. The Pit 9 project at the Idaho Falls site is one of such
contracts intended to clean up DOE’s radioactive wastes. Fit 9 is an
inactive disposal site about 1 acre in size. In the 196Os,DOE used it to
dispose of radiologically contaminated and hazardous wastes, most of
which were packaged in barrels and boxes and covered with soil. The Pit
9 project is being implemented through a contract between Lockheed
Martin Idaho Technologies Company, the M&O contractor, and Lockheed
Martin Advanced Environmental Systems, a subcontractor.

The Federal Acquisition Regulation (FAR) contains overall procurement
and contracting requirements for federal executive agencies. DOE has
also issued supplemental requirements in the Department of Energy
Acquisition Regulation (DEAR). The DEAR includes detailed controls
over M&O contractors and their subcontracting and procurement
practices. DOE’s contracting officers are responsible for ensuring that
M&O contractors conform to the relevant regulations.

3                                GAOlRCED-9&30R DOE’s Subcontracting   Practices
B-278476                                                 _

The type of contract between DOE and its prime contractor determines
the extent of DOE’s controls over the contractor’s procurements,
including transactions between corporate affiliates. Controls are stronger
when the prime contract is a cost-reimbursement contract because under
such a contract costs potentially can be added and passed through to the
government. As a result, DOE looks more closely at the costs incurred
and generally prohibits the addition of an amount for profit in a
subcontract with a corporate affiliate. In the case of the Pit 9
subcontract, even though the M&O contract was a cost-reimbursement
contract, DOE allowed the subcontract to include a profit because it
determined that the initial selection of the subcontract firm was not a
transaction between corporate af6liates.

DOE Oversees Contracts Between Affiliates
When the Prime Contract is a Cost-Reimbursement Contract

When the prime contract between DOE and a company is on a cost-
reimbursement basis, as is the case with most M&O contracts, DOE has
detailed procedures to follow in overseeing the contractor’s procurements.
Because M&O contractors usually obtain needed goods and services
through subcontracung, DOE must ensure that the M&O’s procurement
system meets the standards established by the DEAR. To do so, the DOE
contracting officer (1) requires the M&O contractor to maintain written
descriptions of its procurement system and submit those descriptions for
review and approval, (2) ensures that periodic appraisals of the
contractor’s procurement system are performed, and (3) sets threshold
levels by types of transactions and reviews and approves individual
purchasing actions that exceed those threshold levels. For example, at
the Idaho FalIs site, the DOE contracting officer must review and approve
the M&O contractor’s procurement of individual transactions for $2
million or more.

These requirements do not preclude contractors from entering into
subcontracts with affiliated companies. However, DOE monitors these
transactions to ensure that the government is getting a good value.
Regardless of whether the subcontract is cost-reimbursement or fixed-
price, such subcontracted transactions generally require review and
approval by the DOE contracting officer. In addition, the subcontract
with the affiliate would generally not be ahowed to include an amount for

4                                GAOLRCED-9%30R DOE’s Subcontracting   Practices

profit unless a similar amount was subtracted from the M&O contractor’s
profit (normally referred to as the “fee” for a cost-reimbursement

DOE Does Not Oversee Contracts Between Affiliates
When the Prime Contract Is a Fixed-Price Contract

When a prime contract is awarded on a tied-price basis, with the prime
contractor being paid a specified amount that is not subject to adjustment
on the basis of the contractor’s actual costs, DOE is generally
unconcerned about subcontracts with affiliates. Since DOE would be
paying a fixed price regardless of the costs the contractor incurred,
subcontracting with a corporate mate      would not adversely affect DOE’s
overall costs. Therefore, the stronger controls DOE places on cost-
reimbursement prime contracts are not needed under fixed-price prime

Profit on Pit 9 Subcontract Was Allowed
Because of Suecial Circumstances

The M&O contractor at the Idaho Falls site-Lockheed Martin Idaho
Technologies Company-has a cost-reimbursement prime contract with
DOE. The Pit 9 subcontract is a fixed-price subcontract between
Lockheed Martin Idaho Technologies Company and Lockheed Martin
Advanced Environmental Systems, a subcontractor. Since the M&O
contract is a cost-reimbursement prime contract, DOE would generally
prohibit the subcontractor from including an amount for profit in the
subcontract because it is between corporate affiliates. However, the Bit 9
subcontract was a special case in which DOE allowed a profit to be

The exception for the Pit 9 subcontract occurred because when Lockheed
Martin Advanced Environmental Systems was initially selected for the
subcontract, no corporate affiliation existed between it and the initial
M&O contractor. The procurement for the Pit 9 subcontract was
conducted by the previous M&O contractor at the Idaho Falls site-EG&G
Idaho. EG&G Idaho evaluated the proposals and selected the Lockheed
Martin company to perform the Pit 9 subcontract. During this same
period, DOE recompeted the M&O contract at the site. After Lockheed
Martin Advanced Environmental Systems was selected for the Pit 9
project but before the final price was negotiated for the fixed-price
subcontract, Lockheed Martin Idaho Technologies Company won the M&O

5                               GAO/RCED-9%30R DOE’s Subcontracting   Practices
                                  ,; .,...

B-278476                                                 -

contract for the Idaho Falls site. This M&O contract was awarded on a
cost-reimbursement basis. Because the contracting relationship for the Pit
9 project would now involve two affiliated companies, DOE decided to
assume responsibility for the final Pit 9 subcontract negotiations.
According to DOE officials, DOE also decided that because Lockheed
Martin Advanced Environmental Systems had been selected by EG&G
Idaho and not by Lockheed Martin Idaho Technologies Company, an
amount for profit was allowable. DOE approved a profit as part of the
subcontract price, without requiring the new M&O contractor to reduce its
profit (called a “fee” for a cost-reimbursement contract) by an equivalent
amount. If the subcontract had been ruled a transaction between
corporate af%liates, the DEAR would have required a reduction in the
M&O contractor’s payment to offset the profit going to the corporate

Although DOE allowed a profit to be included in the Pit 9 subcontract, it
also took steps to further oversee the corporate relationship created in
the middle of the subcontracting process. Although DOE conducted the
price negotiations for the subcontract, the Lockheed Martin M&O
contractor signed the subcontract with Lockheed Martin Advanced
Environmental Systems and was responsible for administering the
subcontract. DOE was concerned about the potential conflict of interest
associated with one corporate affiliate overseeing a subcontract with
another. To address this concern, DOE required the Lockheed Martin
M&O contractor to prepare an organizational conflict of interest plan,
which included the establishment of a program oversight board with
members from DOE, Lockheed Martin Idaho Technologies Company, and
an impartial third party to monitor the dealings between the two
Lockheed Martin companies.


DOE generally lacks the authority to ensure that suppliers or companies
that do work for contractors or subcontractors receive payment for their
services. An exception exists for federal construction projects, which
include a requirement under the Miller Act (40 USC. 270a et seq.) that
contractors provide the government with a payment bond to ensure that
suppliers of labor and materials will receive payment for their efforts. For
other than construction contracts, the Miller Act does not apply.
However, DOE officials said that, as a general practice, they look into any

6                                 GAO/RCED-9%30R DOE’s Subcontracting   Practices
 D-278476                                                      -
 allegations that DOE’s contractors are not acting responsibly in carrying
 out work at DOE’s sites.                                  _.

 The Miller Act requires that for federal construction contracts-contracts
 “for the construction, alteration, or repair of any public building or public
 work of the United States” exceeding $lOO,OOO-thecontractor must post a
 performance bond that protects the government in case the contractor
 fails to complete its contract and a separate payment bond that-protects
 suppliers of labor and materials against nonpayment by the contractor.
 Suppliers and subcontractors that do not receive payment from the
 contractor for their work or materials may file a claim against the
 payment bond to collect the amounts owed.

  While the Miller Act and implementing regulations require bonds for
  federal construction contracts, the FAR specifies that generally agencies
  shah not require either performance or payment bonds for other than
  construction contracts. DOE does not generally require payment bonds
  on other types of contracts; rather, it relies on its contractors to act
  responsibly and pay their suppliers. DOE also encourages its M&O
  contractors to establish an ombudsman or a similar program to handle the
- questions or concerns of their subcontractors and suppliers. Nevertheless,
  DOE officials at the Idaho FaUs site and in headquarters stated that, even
  without direct authority, they look into complaints against DOE’s
  contractors and work informally to resolve problems.

 In the case of the Pit 9 project, DOE determined that the Miller Act did
 not apply and therefore a payment bond was not required. The project
 was structured so that Lockheed Martin Advanced Environmental Systems
 was to finance, design, build, own, and operate the Pit 9 facilities with
 DOE paying for the remediation of the Pit 9 wastes on a unit-price basis.
 According to DOE officials, DOE decided that the Miller Act did not apply
 because (1) DOE was purchasing the performance of a service rather than
 the construction of a facility, and (2) the completed facilities would be
 owned by the private contractor and would not be considered public

 During the Pit 9 project, one company complained that it had not been
 paid by Lockheed Martin Advanced Environmental Systems for proposed
 design work on an anaQtical laboratory. DOE reviewed the complaint to
 determine if it was legitimate. DOE concluded that the complaint was not
 legitimate because no subcontract existed between Lockheed Martin

 7                                 GAOIRCED-9830R   DOE’s Subcontracting   Practices
B-278476                                                 .
Advanced Environmental Systems and the company registering the
complaint.                                        _

We provided a draft of our report to DOE for its review and comment. In
its written comments (see enc. I), DOE said that, generally, the report was
a balanced and accurate description of DOE’s oversight of subcontracts
between corporate a.t%iJiates.However, DOE (1) disagreed that the Pit 9
subcontract was a transaction between corporate affiliates and (2)
suggested that we provide more information on DOE’s regulatory
framework for a%liate transactions.

DOE said our report should state that the Pit 9 subcontract award was
not a transaction between corporate affiliates. According to DOE’s
Deputy Assistant Secretary for Procurement and Assistance Management,
because EG&G Idaho selected Lockheed Martin Advanced Environmental
Systems for the Pit 9 subcontract and because EG&G Idaho had no
affiliate relationship with Lockheed Martin Advanced Environmental
Systems, the subcontract award was not an affiliate transaction. While we
agree that the initial selection of Lockheed Martin Advanced
Environmental Systems as the Pit 9 subcontractor did not involve two
affiliated companies, the resulting subcontract, which defined the
subcontract’s requirements and price, was a subcontract between two
corporate affiliates, now called Lockheed Martin Idaho Technologies
Company and Lockheed Martin Advanced Environmental Systems.
Therefore, in our view, the Pit 9 subcontract was a transaction between
corporate affiliates.

Regarding the discussion of DOE’s regulatory framework, DOE suggested
that we include in our report a more detailed explanation of DOE’s
regulatory controls over affiliate txutsactions by M&O contractors. We
believe, however, that the report adequately explains these controls
without being overly technical and thus we did not add more detail.

DOE also suggested several clarifications, which we incorporated where


We conducted our review at DOE headquarters, DOE’s Idaho Operations
Office in Idaho Falls, and the offices of its M&O contractor and the

 8                                GAO/RCED-9%30R DOE’s Subcontracting   Practices
B-278476                                                  -
subcontractor for Pit 9. To respond to your questions, we reviewed the
FAR, DEAR, and the Miller Act and other documentation. provided by
DOE and the contractors, including the M&O contract and the Pit 9
subcontract at the Idaho Falls site. In addition, we interviewed
contracting officials with DOE’s Idaho Operations Office, the M&O
contractor, and the subcontractor. To obtain DOE’s overall view on these
questions, we interviewed DOE’s Deputy Assistant Secretary for
Procurement and Assistance Management and the Deputy Assistant
General Counsel for Procurement.

Our work was performed from September through October 1997 in
accordance with generally accepted government auditing standards.

We are sending copies of this report to the Secretary of Energy. We will
also make copies available to other interested parties upon request.

Please call me at (202) 512-8021 if you or your staff have any questions.
Major contributors to this report include William R. Swick, Carole J.
Blackwell, Susan W. Irwin, Stanley G. Stenersen, and Charles A. Sylvis.

    Science Issues

9                                GAOIRCED-9830R   DOE’s Subcontracting   Pradices
ENCLOSURE I                                                                            ENCLOSURE I

                                     Department of Energy
                                         Washington,DC 20585
                                         November 19. 1997

     Ms. Gary L. Jones
     Acting AssociateDirector
     Energy,Resources,and ScienceIssues
     U.S. GeneralAccountingOflice
     441 GStreet.NW
     Washington.DC 20548

     Dear Ms. Jones:

     We havereviewed your draft report entitled DOE’s Subcontractinypractices(GAO/RCED-98-
     3OR Code I4 I 102)and. generally.we find the report to be a balancedand accuratedescriptionof
     subcontractingoversightby the Departmentwith respectto affiliate transactions.We would lie
     to offer the following paragraphsfor your considerationas a more completeand detailed
     explanationof the regulatoryframework which the Depanmentappliesto affiliate transactions.

     The FederalAcquisition Regulation(FAR), which is generallyapplicableto Federalexecutive
     agencies,dealswith the subjectof contractor afI’iliatetransactionsonly in the context of
     contractingagencyreview of contractor purchasingsystems The FAR directs agencies.in their
     review of a cost-reimbursementcontractor’spurchasingsystem.to give “specialattention”to,
     amongother things.the contractor’stransactionswith its affiliates.

     Although the FAR provideslittle guidanceon this matter. the Departmentof Energy Acquisition
     Regulation(DEAR), which containsrequirementsspecific to DOE contractors,provides
     considerablymore detailedguidanceand controls on affiliate transacrionsfor its managementand
     operating(M&O) contractors. DOE regulationsprovide for significantlimitations on how M&O
     contractorsmay purchasefrom affiliates. For example.the DEAR calls for the provision at cost
     by an affiliate where the affiliate receivesa non-competitiveaward for technicalservices
     consistingof a specialexpertiseof the affiliate In all other situationsinvolving the provisionsof
     suppliesor services.it requiresthat the transactionbe conductedin sucha manneras to ensurean
     arms-lengthrelationshipbetweenthe contractingparties It also requiresadvancenotification to
     the ContractingOfficer prior to making purchasesfrom contractor-affiliatedsourcesover a value
     establishedby the Headof the ContractingActivity There are even more restrictionsassociated
     with M&O subcontractswith affiliatesfor the performanceof core contract work itself. Such
     subcontractsrequire DOE authorizationand usuallyinvobtz an adjustmentof the contractor’sfee.
     DOE approvalnormally would require either that the affiliate perform suchwork without fee or
     profit, or that the M&O’s fee be adjusteddownward.

10                                                    GAO/RCED-93-3OR DOE’s Snbcontracting       Practices
                                                                           - .
ENCLOSiJRE I                                                                     ENCLOSURE I

       In additionto thesegeneralcomments,we respectfullyoffer the specificcommentson the
       attachmentfor your considerationfor purposesof ciarity.

       If you haveany additionalquestionsregardingthis matter,pleasecontactme at 202-586-8613.

                                                Procurementand AssistanceManagement

       Commentson Draft Report B-278476

11                                               GAO/RCED-983OR DOE’s Subcontracting    Practices
      ENCLOSURE I                                                                          ENCLOSURE I

                                       COMMENTS ONDRAFTRJZPORTB-278476

Now on p. 5.     i.   On page 7, we recommendchangingthe first four words in the fifth line of rhe first
                      paragraphto read. ‘*. a fee or profit . .*’ratherthan .I. a fee for profit       ”
                 A.   On page 7, we recommendchangingthe last sentenceofthe first paragraphto read.
Now on p. 5.
                      “However. in the caseof the Pit 9 subcontract,the subcontractaward was not, in fact, an
                      afiiiiate transaction.”

                 3.   On page 7. we recommendreplacingthe first two sentencesof the secondparagraphwith
                      the following three sentences:

Now on p. 5.            “When LockheedMartin AdvancedEnvironmentalSystemswas competitivelyselected
                        for the subcontract,no corporate&liation existedbetweenit and the then M&O
                        contractor. The competitiveprocurementfor the Pit 9 subcontractwas conductedby
                        the previousM&O contractor at the Idaho Falls site-EG&G Idaho. EG&G Idaho had ‘,
                        no affiliate relationshipwith LockheedMartin AdvancedEnvironmentalSystems.”

Now on p. 6.     4.   On page 7. we recommendchangingthe eighth and ninth sentences.beginningon the 14th
                      line of the secondparagraph,to readas follows:

                        “According to DOE officials, DOE alsodecidedthat becauseLockheedMartin
                        AdvancedEnvironmentalSystemshadbeenselectedby EG&G Idaho and not by
                        LockheedMartin Idaho TechnologiesCompany,a subcontractfee was permissible.
                        DOE approveda fee as part of the subcontractprice, without requiring the new M&O
                        contractor to reduceits fee by an equivalentamount.”

Now on p. 6.          On page 8. we recommendchangingthe terms +. fee for profit         . .‘* on the secondand
                      third tinesat the top ofthe page, to read,**. fee .”

                      On page 8. we recommendrevisingthe last sentenceof the first full paragraph and adding
                      a new last sentenceto the paragraphto read as foiiows:

 Now on p. 6.           “To addressthis concern DOE requiredthe LockheedMartin M&O contractor to
                        preparean organizationalconflict of interestplan. which includedthe establishmentof a
                        program oversightboard with membersfrom DOE. LockheedMartin Idaho
                        TechnologiesCompany.and an impartialthird party to monitor the dealingsbetweenthe
                        two LockheedMartin companies.DOE reportsthat the organizationalconflict of
                        interest plan has worked well, andthat the affiliate relationshiphas not affectedthe
                        LockheedMartin M&O contractor in its aggressiveadministrationof the subcontract.”


      12                                                   GAO/RCED-98-30R
                                                                         DOE’sSubcontracting Practices
Ordering    Information

The first copy of each GAO report and testimony is free.
Additional   copies are $2 each. Orders should be sent to the
following address, accompanied by a check or money order
made out to the Superintendent     of Documents, when
necessary. VISA and Master-Card credit cards are accepted, also.
Orders for 100 or more copies to be mailed to a single address
are discounted 25 percent.

Orders by mail:

U.S. General Accounting   Office
P.O. Box 37050
Washington, DC 20013

or visit:

Room 1100
700 4th St. NW (corner of 4th and G Sts. NW)
U.S. General Accounting Office
Washington, DC

Orders may also be placed by calling (202) 512-6000
or by using fa;x number (202) 512-6061, or TDD (202)      512-2537.

Each day, GAO issues a list of newly available reports and
testimony.   To receive facsimile copies of the daily list or any
list from the past 30 days, please call (202) 512-6000 using a
touchtone phone. A recorded menu will provide information         on
how to obtain these lists.

For information on how to access GAO reports on the INTERNET,
send au e-mail message with “info” in the body to:


or visit GAO’s World Wide Web Home Page at:

United States
General Accounting    Office               Bulk Rate
Washington,   D.C. 20548-0001        Postage & Fees P’-’
Official   Business                    Permit No. GlOO
PenaIty    for private   Use $300

Address    Correction    Requested