[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]


                                     

                         [H.A.S.C. No. 111-100]
 
   CAN THE DEPARTMENT OF DEFENSE PROTECT TAXPAYERS WHEN IT PAYS ITS 
                              CONTRACTORS?

                               __________

                                HEARING

                               BEFORE THE

                  PANEL ON DEFENSE ACQUISITION REFORM

                                 OF THE

                      COMMITTEE ON ARMED SERVICES

                        HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                              HEARING HELD

                            OCTOBER 15, 2009

                                     
[GRAPHIC] [TIFF OMITTED] TONGRESS.#13

                                     

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                  PANEL ON DEFENSE ACQUISITION REFORM

                  ROBERT ANDREWS, New Jersey, Chairman
JIM COOPER, Tennessee                K. MICHAEL CONAWAY, Texas
BRAD ELLSWORTH, Indiana              DUNCAN HUNTER, California
JOE SESTAK, Pennsylvania             MIKE COFFMAN, Colorado
                Andrew Hunter, Professional Staff Member
                 John Wason, Professional Staff Member
                     Alicia Haley, Staff Assistant


                            C O N T E N T S

                              ----------                              

                     CHRONOLOGICAL LIST OF HEARINGS
                                  2009

                                                                   Page

Hearing:

Thursday, October 15, 2009, Can the Department Of Defense Protect 
  Taxpayers When It Pays Its Contractors?........................     1

Appendix:

Thursday, October 15, 2009.......................................    29
                              ----------                              

                       THURSDAY, OCTOBER 15, 2009
   CAN THE DEPARTMENT OF DEFENSE PROTECT TAXPAYERS WHEN IT PAYS ITS 
                              CONTRACTORS?
              STATEMENTS PRESENTED BY MEMBERS OF CONGRESS

Andrews, Hon. Robert, a Representative from New Jersey, Chairman, 
  Panel on Defense Acquisition Reform............................     1
Conaway, Hon. K. Michael, a Representative from Texas, Ranking 
  Member, Panel on Defense Acquisition Reform....................     4

                               WITNESSES

Assad, Shay, Director, Defense Procurement and Acquisition 
  Policy, U.S. Department of Defense.............................     6
Kutz, Gregory D., Managing Director, Forensic Audits and Special 
  Investigations, U.S. Government Accountability Office..........    11
Stephenson, April G., Director, Defense Contract Audit Agency, 
  U.S. Department of Defense.....................................     8

                                APPENDIX

Prepared Statements:

    Andrews, Hon. Robert.........................................    33
    Assad, Shay..................................................    36
    Conaway, Hon. K. Michael.....................................    34
    Kutz, Gregory D..............................................    78
    Stephenson, April G..........................................    48

Documents Submitted for the Record:

    Defense Contract Audit Agency Performance-Based Actions......    97

Witness Responses to Questions Asked During the Hearing:

    [There were no Questions submitted during the hearing.]

Questions Submitted by Members Post Hearing:

    [There were no Questions submitted post hearing.]
   CAN THE DEPARTMENT OF DEFENSE PROTECT TAXPAYERS WHEN IT PAYS ITS 
                              CONTRACTORS?

                              ----------                              

                  House of Representatives,
                       Committee on Armed Services,
                          Defense Acquisition Reform Panel,
                        Washington, DC, Thursday, October 15, 2009.
    The panel met, pursuant to call, at 8:02 a.m., in room 
1310, Longworth House Office Building, Hon. Robert Andrews 
(chairman of the panel) presiding.

OPENING STATEMENT OF HON. ROBERT ANDREWS, A REPRESENTATIVE FROM 
   NEW JERSEY, CHAIRMAN, PANEL ON DEFENSE ACQUISITION REFORM

    Mr. Andrews. Ladies and gentlemen, good morning. We 
appreciate your attendance this morning. Welcome, my colleagues 
on the panel.
    The panel has been engaged in an investigation of 
hypotheses as to the reasons why there is a difference between 
the price that the taxpayers pay and the value that those who 
wear the uniform of our country and serve our country receive 
when we buy goods and services. We start from the proposition 
that there is not always a gap between those. There are many 
instances where, in fact, we get full value for what we pay. 
And we are very grateful for that.
    Last week we had an example of that when we looked at the 
excellence that occurred in the Mine Resistant Ambush Protected 
vehicle (MRAP) program. Good things have happened there.
    Suffice it to say, though, that we are concerned that, 
whether it is major weapons systems, services, or other kinds 
of goods and supplies, that there are too many instances where 
we pay a dollar and get 75 or 80 cents worth of value. There is 
unanimity on Republicans and Democrats, House and Senate, 
executive branch and legislative branch, certainly among the 
American people, that we want to do a lot better than that. So 
we have engaged in a series of hearings where we have looked at 
various hypotheses as to why that gap exists.
    For instance, we have looked at the way that we don't, I 
think, quite understand the right way to buy information 
technology. By using a paradigm that tracks the paradigm we use 
for hardware, we make some mistakes in that area.
    We have looked at the issue of whether our workforce is not 
right-sized and not correctly trained to deal with these 
issues. We have looked at questions concerning the supply 
chain, whether it is properly organized, properly managed and 
so forth.
    This morning we are going to look at a question that is a 
little narrower than what I just talked about, but certainly 
not any less important. And that is, how well are we doing at 
auditing the contracts that we let? In other words, if we were 
to ask this morning on a contract for a certain communications 
system, are we behind in our payments or ahead in our payments? 
Have we paid what we should have or not? Has the work that is 
supposed to be done for what we have been paid been done or 
not?
    The Department of Defense (DOD) is charged with an enormous 
responsibility in monitoring huge amounts of money and 
literally hundreds of thousands of contracts at any given time. 
So it is a very important job. But, frankly, work in recent 
times by the Government Accountability Office has raised some 
serious concerns as to whether we are properly organizing 
ourselves to do the auditing and monitoring of contracts.
    This morning we are going to hear about the nature of those 
concerns, some efforts to address those concerns which are 
going on at the Defense Contract Audit Agency (DCAA) and other 
instruments of the Department of Defense, and then help the 
panel make an assessment of how we can do this whole process 
better.
    And I want to begin with two cultural snapshots of issues 
within the DCAA, which are elucidated in a report done by the 
Government Accountability Office last month that I believe was 
at the request of Senators Lieberman and Collins, but are 
certainly important for the entire Congress.
    And I do use the phrase ``cultural snapshot,'' because I 
understand that the two instances about which I am going to 
refer, or to which I am going to refer, may or may not be 
representative of the systemic situation. But whether they are 
representative of the systemic situation or unrepresentative, 
they are troubling.
    The first cultural snapshot is a problem of, I would say, 
too much engagement with a contractor. In May of 2005, 
according to the Government Accountability Office (GAO), in the 
eastern region of DCAA, there was an issue with a billing 
system contract. The DCAA reported an inadequate in part 
opinion of the billing system internal controls of one of the 
five largest DOD contractors.
    After issuing the report, DCAA auditors helped the 
contractor develop policies and procedures related to the 
accounts receivable, overpayments and system monitoring before 
performing a required follow-up audit, which is a significant 
impairment to the independence of the auditors. So we sort of 
have a joint venture, if you will, between the auditors and the 
people being audited before there is a follow-up audit.
    In June 2006, the DCAA reported an adequate opinion on the 
contractor's billing system, internal controls, including the 
price, policies and procedures DCAA helped the contractor 
develop. So the problem here obviously was the auditor was 
auditing in part its own work product. As a result of GAO's 
review, the DCAA rescinded the follow-up audit report on March 
the 6th of this year of 2009. So there is an instance where the 
line between the auditor and the audited was unfortunately 
blurred.
    The second instance is kind of the opposite problem. This 
was in the central region of DCAA, 2006, again involving a 
billing system case. A fraud investigation by the Army's 
Criminal Investigation Division was under way at the time the 
DCAA performed a given contractor's billing system audit. So 
the facts are that the contractor is under criminal 
investigation at the time, and there is an audit of the 
contractor's billing system.
    The auditors were aware of the substance of the Army's 
investigation. So there is knowledge of the auditors what is 
going on. The auditor requested increases in budget audit hours 
to perform increased testing because of the fraud risk and the 
contractor's use of temporary accounts for charging costs that 
had not yet been authorized by the contracting officer. So the 
person that DCAA puts in blows the whistle and says, ``I need 
more help because there are some things that raise a red flag 
here.''
    The auditor then drafts an inadequate opinion on the 
contractor's billing system, which was overturned by the 
supervisor and Field Audit Office (FAO) manager. So the person 
who is on site reaches the conclusion that an inadequate report 
is the right result. Her opinion is overturned.
    Despite a reported $2.8 million in fraud for the contractor 
in question, the DCAA reported an inadequate in part opinion 
related to three significant deficiencies in the contractor's 
billing system on August 31, 2005 and an adequate opinion then 
on September 11, 2006, regarding a follow-up audit. The auditor 
on the ground, the initial auditor, whose performance appraisal 
was lowered for performing too much testing and exceeding 
budgeted hours, was assigned to and then removed from the 
follow-up audit. This auditor then left the agency in March of 
2007.
    So then to briefly review the facts, the person who is on 
the ground sees the red flag, asks for more help, renders an 
opinion that is, frankly, a negative opinion of the contractor. 
That opinion is essentially reversed in a follow-up audit. And 
the person who is on the ground is excluded from the follow-up 
audit and, in effect, disciplined and sanctioned because she 
put too much time into the first audit and asked for too much 
help.
    Following the GAO's review of this matter, the DCAA 
rescinded both audit reports on November 20th of 2008. Now, 
again, I am not claiming that these are systemic examples. I 
think that is research that is yet to be done and an analysis 
that is yet to be done.
    But I think the members of the panel would agree that they 
are disturbing examples because on the one hand, there is an 
example of blurring the line between the auditor and the 
audited. The other case there is an example of someone who is 
quite aggressive as an auditor, who it appears was sanctioned 
for her appropriate behavior, and that an unfortunate and 
incorrect result was reached in the end.
    The importance of these examples is self-evident for the 
facts of the example. But the importance goes beyond that. It 
is sort of the fruit of the poisonous tree doctrine because 
once there is a finding, that finding then spreads through the 
system.
    For example, once a contractor is put into the green light 
list, the good guy list, the level of attention and auditing 
that is paid to that contractor diminishes. There is sort of a 
presumption that the contractor is okay. So a mistake that is 
made in one audit has potentially negative consequences for 
many, many contracting decisions down the road. This is not 
simply a contract-by-contract decision.
    It is a big job that the DCAA has. But what we are 
interested in hearing this morning is its reaction to and 
improvements as a result of the work of the GAO and suggestions 
that each of our three witnesses would have on how this panel 
can aid that effort so that we can reach a point where we have 
a high confidence with good reason in our auditing system.
    At this time, I am going to ask my friend, the senior 
Republican on the panel, Mr. Conaway, for his opening 
statement.
    [The prepared statement of Mr. Andrews can be found in the 
Appendix on page 33.]

  STATEMENT OF HON. K. MICHAEL CONAWAY, A REPRESENTATIVE FROM 
   TEXAS, RANKING MEMBER, PANEL ON DEFENSE ACQUISITION REFORM

    Mr. Conaway. Well, thank you, Mr. Chairman.
    And, witnesses, thank you all for being here this morning. 
Today's hearing examines an area of acquisition that is near 
and dear to my heart: auditing. I am a Certified Public 
Accountant (CPA). And I spent my early part of my career doing 
that often thankless task.
    The basic question is how vulnerable is the Department to 
overpaying its contractors on acquisition programs and how 
robust are its systems for preventing overpayments. The Defense 
Contracting Audit Agency provides the department's primary 
internal means of detecting, preventing or correcting the 
majority of potential contractor overpayments.
    There have been recent articles based on GAO findings 
regarding the DCAA. Based on written testimony, there are major 
disagreements between the Department and the GAO. And I would 
only add that we are here today to learn all points of view. We 
have a group of very qualified witnesses. And we are glad that 
you are here to help us understand these issues.
    Finally, I would say that once again a recurring theme has 
been consistent. It has been consistent with our previous panel 
hearings in regards to workforce. In fiscal 2008, DCAA 
performed over 30,000 audits with approximately 4,200 
employees. I believe it is Mr. Assad in his written statement 
that stated, ``Rebuilding the DCAA workforce, while a 
challenge, can and must be done.''
    We learned from previous hearings that increasing the 
workforce isn't always the answer. But in this case, it does 
appear that the workforce is one of the major areas that needs 
to be addressed.
    Looking forward to our witnesses. Let us hear from them.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Conaway can be found in the 
Appendix on page 34.]
    Mr. Andrews. Thank you very much.
    Without objection, opening statements from other members of 
the panel will be made a part of the record.
    I am now going to proceed to read a brief biography of our 
witnesses. I think each of you has had extensive experience on 
the Hill. So you know that, without objection, your written 
statements will be entered into the record of the proceeding. 
And we will ask you to give us about a five-minute oral 
synopsis of your written testimony so we can maximize the time 
for question and answers from the panelists.
    Mr. Shay Assad is the Director of Defense Procurement. He 
assumed that role on April 3rd of 2006. In that position, he is 
responsible for all acquisition and procurement policy matters 
in the Department of Defense. He is the functional leader for 
contracting workforce within the Department of Defense and is 
also responsible for overseeing all strategic sourcing 
activities within the department.
    Before assuming this position, Mr. Assad was the Assistant 
Deputy Commandant, Installations and Logistics for Contractors 
at headquarters of the Marine Corps here in Washington, D.C. 
Upon graduating with distinction from the U.S. Naval Academy in 
1972, he served two tours of duty aboard the U.S. Navy 
destroyers and won recognition as the outstanding junior 
officer of the 5th Naval District.
    He has received numerous federal service awards, which 
include the Secretary of Defense Medal for Exceptional Civilian 
Service, Secretary of Defense Medal for Meritorious Service, 
the Department of Defense Inspector General Joseph H. Sherick 
Award, which is the highest award given to a non-IG employee, 
the 24th annual Gilbert A. Cuneo Lecturer and the inaugural 
recipient of the 2008 Osborne A. ``Oz'' Day Award as the 
federal executive who has done the most to increase the 
awareness of Ability One employment opportunities for those who 
are blind or severely disabled.
    Mr. Assad, thank you for your service and welcome to the 
panel this morning.
    April G. Stephenson is the director of the DCAA. She is 
responsible for all matters related to the management of the 
agency and its resources. She began her career in the agency in 
1987 as an auditor trainee in Mountain View, California.
    She progressed through DCAA holding various positions, such 
as supervisory auditor, program manager, branch manager, 
various positions in the Policy Directorate at headquarters. 
She assumed the responsibility as Director in February of 2008, 
and she serves as the Secretary's appointee on the Cost 
Accounting Standards Board.
    She has her B.S. degree in Business Administration from 
California State University at Chico and has a Masters in 
Administration from Central Michigan University.
    She is licensed, Michael, as a CPA in the state of North 
Carolina. That will make you happy.
    She is a member of several professional organizations, 
including the American Institute of Certified Public 
Accountants (AICPA) and the Institute of Management 
Accountants. She has received numerous awards and recognition 
throughout her DCAA career. She resides in Alexandria, 
Virginia. And in her spare time, which I assume is very scarce, 
given your responsibilities, she enjoys bird watching, 
gardening and reading.
    Welcome, Ms. Stephenson. We appreciate your service and 
glad you are here this morning.
    And Greg Kutz----
    Did I get that, Greg, right? I am sorry--is the managing 
director of GAO's Forensic Audits and Special Investigations 
Unit. The mission of that unit is to provide us in the Congress 
with high quality forensic audits and investigations of fraud, 
waste and abuse and evaluations of security vulnerabilities and 
other requested investigative services.
    He is a graduate of Penn State in 1983. He joined the D.C. 
office of KPMG Peat Marwick after graduation. He worked there 
for eight years. In 1991 he joined the GAO. As a senior 
executive at GAO, Mr. Kutz has been responsible for reports 
issued by GAO in testimony regarding the credit card and travel 
fraud and abuse, improper sales of sensitive military and dual 
use technology, a number of areas.
    Most recently, he and I had the chance to work together on 
some disturbing issues of children being subjected to physical 
restraints in certain educational settings and did a great work 
in that regard.
    Mr. Kutz is a Certified Public Accountant and Certified 
Fraud Examiner, and we welcome him to the panel and appreciate 
his service.
    So, Mr. Assad, we will begin with you. Welcome.

  STATEMENT OF SHAY ASSAD, DIRECTOR, DEFENSE PROCUREMENT AND 
         ACQUISITION POLICY, U.S. DEPARTMENT OF DEFENSE

    Mr. Assad. Thank you, Mr. Chairman.
    First of all, let me say that I am very appreciative of the 
panel's focus and concern about this issue of getting a better 
deal for the taxpayers. I couldn't be more supportive and more 
aligned with that thought. We call it--I call it--the quality 
of the deal when I go out and speak to our employees in the 
field, and I have spoken to well in excess of 10,000 of them 
about this issue of getting a better deal for the taxpayers.
    There is a disparity in far too many instances between what 
we are paying and the quality we are getting. We need to get a 
better deal. And that is why we have taken the actions that we 
have with regard to our workforce. That is why we are focused 
on improving the cost estimating and pricing capability within 
the department.
    It is absolutely essential and critical that we improve the 
quality of the deal. With budgets the way they are, we have got 
to get better value for every dollar that we spend for the 
taxpayers.
    Thank you for the opportunity to appear today and to 
participate in today's discussion. As a senior leader of the 
defense contracting workforce, I cannot stress enough the 
crucial role that DCAA plays in the department's procurement. I 
assure you that all of our contracting officers value and rely 
significantly upon the professional advice rendered by DCAA.
    We recognize that the Government Accountability Office has 
recently identified needed improvements in DCAA's auditing 
processes. To assist DCAA in addressing the concerns 
identified, Under Secretary Hale established an oversight 
committee to provide advice and recommendations concerning DCAA 
matters.
    As the department's senior procurement executive, I am also 
a member of the DCAA oversight committee. The senior group will 
assess DCAA's activities and the actions taken to correct 
problems identified by GAO and others.
    As Under Secretary Hale has pointed out in his testimony 
before the Senate Homeland Security and Government Affairs 
Committee last month, in my role as the Director of Defense 
Procurement, I represent the key customer for DCAA. Given that, 
I would like to offer you just a few thoughts on a few areas 
identified for improvement by GAO.
    First of all, with regard to this term called ``production 
auditing,'' it has been suggested that the challenges at DCAA 
center around production oriented auditing and that audits have 
been rushed to meet contracting officer requirements. This sets 
up a real tension and a dichotomy between getting quality 
audits and getting timely audits.
    An audit not delivered in a timely manner is of limited 
value to the government. On the other hand, it has got to be 
quality work or it doesn't achieve the objective, which is 
getting the best deal we can for the taxpayers.
    But a good audit in time is better than an extraordinary 
audit that is late and never used. An audit is the tool of a 
contracting officer used to negotiate a contract, but in order 
to realize those benefits, it has to be of a quality nature, 
and it has to be timely.
    While the GAO report cites examples of poor quality audits 
and some poor decisions that may have been made by DCAA in the 
past, most would seem to be heavily focused and influenced by 
inadequate staffing.
    Based on our discussions with contracting officers, 
contractors and auditors, some--and possibly most--of the 
reductions in audit scope and responsiveness by DCAA is a 
direct result of the staffing draw down while workload 
increased. Until the staffing issues are resolved, it will not 
be possible for DCAA to perform at the level of quality and 
efficiency that is desired. Rebuilding the DCAA workforce, 
while a challenge, can and must be done.
    The Panel on Contracting Integrity, which was really 
established at the initiation of the House Armed Services 
Committee, has proved to be a very productive and successful 
forum for making progress in eliminating vulnerabilities that 
lead to fraud, waste and abuse.
    Given the success of that panel, we have recently 
established a new interdepartmental subcommittee that will 
address the adequacy of DCAA and the Defense Contract 
Management Agency--DCMA--oversight of contractor business 
systems. They both serve in that function. We expect this 
subcommittee to make a number of recommendations to improve the 
oversight with regard to business systems.
    Again, I would like to thank the panel for holding this 
hearing, and I can assure you that we are focused on the 
quality of the deal and getting a better deal for our 
taxpayers. Thank you.
    [The prepared statement of Mr. Assad can be found in the 
Appendix on page 36.]
    Mr. Andrews. Thank you, Mr. Assad. Thank you very much.
    Ms. Stephenson. Welcome to the panel.

 STATEMENT OF APRIL G. STEPHENSON, DIRECTOR, DEFENSE CONTRACT 
            AUDIT AGENCY, U.S. DEPARTMENT OF DEFENSE

    Ms. Stephenson. Members of the panel, thank you for the 
opportunity to be here today, and I sincerely appreciate your 
concerns in the matters regarding DCAA and the issues that we 
have had with quality and other issues.
    And I assure you we are taking every effort we can to 
improve this audit process to ensure, as Mr. Assad said, the 
contracting officers are getting the quality product they need 
in order to make the best decisions for the best fair and 
reasonable prices the government can have, because ultimately 
what we need is the best value for the warfighter. That is what 
we are all here for.
    My testimony today has two parts. First, I will briefly 
describe the role of DCAA in the acquisition process, 
challenges in auditing contractor costs, and vulnerabilities in 
acquisition. Second, I will briefly describe several of the 
improvements we have made in findings to the GAO reviews.
    DCAA is a distinct agency in the Department of Defense that 
reports to the Under Secretary Comptroller. The DCAA mission is 
to perform all the necessary contract audits of contractors. We 
don't audit government organizations. We audit the contractors 
for the DOD components that are responsible for negotiation, 
administration and settlement of contracts. Under the 
acquisition regulations, not all contracts are subject to DCAA 
audits.
    In 2009 DCAA performed over 21,000 audits covering $330 
billion in contractor costs. These audits recommended 
reductions in proposed or build costs of $20 billion, and $12 
billion in estimated costs where the contractor did not provide 
sufficient information to support the costs.
    DCAA has about 4,400 employees at 105 field offices around 
the world. Decision-making authority on DCAA recommendations 
resides with contracting officers within the procurement 
organizations that work closely with DCAA throughout the 
contracting process. The type and extent of DCAA audit work 
varies, depending on the type of contract awarded.
    DCAA performs audits of contractor bid proposals prior to 
award for both fixed price and cost reimbursable contracts when 
cost data is provided and contracting officials determine the 
need for an audit. After contract award, audit effort is 
concentrated on cost reimbursable contracts. These contracts 
pose an increased risk of overspending, often with little 
incentive to control costs.
    Regulations covering acquisitions using competitive 
procedures and commercial item procedures rarely involve DCAA 
audit services. The regulations generally prohibit contracting 
officials from obtaining cost data from contractors to support 
the bid estimate.
    In theory, when cost data is not required, DCAA audit 
support is not required. This theory holds true when the 
government is one of many buyers of identical goods and 
services in the marketplace. However, there are instances 
where, due to the magnitude of complexity of the government's 
requirements, the marketplace is limited or nonexistent, and 
consequently, market forces are not driving contract prices.
    DCAA has faced a number of challenges in auditing 
contractors. I have detailed these more in my written 
statement, but in essence there are three major challenges that 
we have.
    The first one Mr. Assad briefly mentioned, and that is the 
contracting officers' need for speed, as we call it, in 
awarding contracts is often at times at odds with the time 
necessary for DCAA to perform sufficient testing and auditing 
procedures.
    Second, DCAA auditors are often faced with delays in 
obtaining data from contractors, and this has resulted in some 
audits taking longer than is necessary. Such delays in 
providing information from contractors is sometimes an attempt 
to stall the timely completion of the audits, knowing that we 
do have a need for speed in awarding these contracts. Such 
delays are unacceptable.
    We often face challenges for contractors' commitment to 
correct business system deficiencies. And as Mr. Assad stated, 
this is going to be addressed under the new subcommittee under 
the Panel on Contracting Integrity.
    As far as contracting vulnerabilities, we have mentioned 
three in our testimony, one being the commercial item 
definition has two areas of vulnerability of a type and offered 
for sale. This is also being addressed by the Adequate Pricing 
Subcommittee of the Panel on Contracting Integrity and which I 
chair.
    Second is competitive pricing when only one bid is 
submitted. In one of these cases, and one case that I discuss 
in my testimony, we had an instance where a contractor received 
profit in excess of 30 percent on a competitively awarded firm 
fixed-price contract where only one bid was submitted.
    Time and material contracts have also been an area of risk 
and continue to be looked at for the Department.
    Now, regarding the GAO's review, in my written testimony I 
have detailed a number of improvements we have taken. We have 
taken over 50 specific improvement actions in the past year to 
address these issues, but there are two in which I want to 
briefly discuss. I realize my time is close, and I just ask if 
you would let me just briefly discuss these two----
    Mr. Andrews. Yes, of course. Please take the time. Yes, 
ma'am.
    Ms. Stephenson [continuing]. The first being in the 
independence issue, as you mentioned, Mr. Chairman. 
Independence is really at the heart at what an auditor 
performs. I am sure that anyone that is familiar with the 
auditing standards knows that that is the basic tenet of what 
an auditor does, and we were certainly quite appalled at some 
of the things in which the GAO discovered, both in 2008, 2009, 
regarding independence.
    There were two major areas that led to the independence 
concerns, and unfortunately, these were processes that were not 
only supported, but also encouraged by the Department, and 
which we have now ceased.
    First was involvement in what is called an integrated 
product team, which is where the government would team with the 
contractor, and that government, including DCAA, would often 
sit at the table as the contractor was putting together their 
bid estimate or an improvement plan or whatever else it is that 
they are working with the government.
    DCAA would often be at the table and offer suggestions on 
draft procedures or draft parts of the proposal as a contractor 
was putting it together and then audit that proposal once it 
was submitted. We have ceased that process. That process was 
stopped in August of 2008.
    We no longer sit at the table. We no longer participate in 
joint meetings with the contractors prior to an audit. We will 
support the contracting officer, but we will not be involved 
with anything related to a draft. We will only perform audits 
once the contractor has said this is a final submission for the 
government.
    That was a major change we made in the summer of 2008, and 
we worked with Mr. Assad and the service acquisition chiefs in 
an attempt to have a smooth transition from that process, 
because that was a major change.
    A second change that led to independence were in areas such 
as what you described, Mr. Chairman, in your opening statement 
about when a contractor had inadequate systems. We would often 
review their draft policies and procedures to offer comments as 
to whether it was headed in the right direction. It wasn't as 
though we prepared them, but we did provide feedback as to 
whether, yes, we think this would correct it, or, no, you are 
off base, you need to do something more.
    That was something that was also supported by the 
department in an attempt to try to resolve system deficiencies 
on a timely basis and try to get them corrected sooner rather 
than waiting till a complete system was put in place and DCAA 
come in and audit.
    We realized that that could have--and as the GAO said--
could impair auditors' objectivity to give feedback on a draft 
policy and procedure, and then audit that policy and procedure. 
We have ceased that process as well. We will no longer offer 
any sort of comments on a draft procedure. Only once it is 
completed and implemented and actually had transactions run 
through the system for several periods, then we will test that.
    It will result in some delay in resolving these issues. But 
we feel that that will improve our independence.
    The last one I want to discuss is risk-based planning. And 
this was an area that the GAO had suggested that we implement, 
and we have in 2010.
    We have staffing to cover about 65 percent of the required 
audits that need to be done. Because of that, we have had to 
focus our audit efforts in 2010 with those audits that are the 
highest risk to the Department.
    One area we define as high risk is the greatest rate of 
return back to the Department--that being war-related effort, 
that being bid proposal, and also the accounting and billing 
systems at our largest contractors.
    And in closing, Mr. Chairman and members of the panel, 
thank you for this hearing today. We do appreciate being part 
of the panel's efforts on acquisition issues, and we would not 
mind coming back again and talking about other issues with you.
    But I do want to leave you with a thought. We have taken 
all these issues with the utmost seriousness, because our 
audits have to stand on their own. They have to be in 
accordance with the auditing standards. But at the same time, 
we need to make sure contracting officers get them in a timely 
basis, so they can make good decisions.
    Mr. Chairman, thank you for the extra time.
    [The prepared statement of Ms. Stephenson can be found in 
the Appendix on page 48.]
    Mr. Andrews. Thank you, Ms. Stephenson. We appreciate your 
efforts and your contribution.
    Mr. Kutz, welcome to the panel.

   STATEMENT OF GREGORY D. KUTZ, MANAGING DIRECTOR, FORENSIC 
      AUDITS AND SPECIAL INVESTIGATIONS, U.S. GOVERNMENT 
                     ACCOUNTABILITY OFFICE

    Mr. Kutz. Mr. Chairman and members of the panel, thank you 
for the opportunity to discuss defense acquisition reform.
    My testimony has two parts. First, I will discuss our 
recent work related to the Defense Contract Audit Agency. And 
second, I will briefly discuss our high-risk acquisition areas.
    First, our recent work on DCAA began with allegations we 
received on our hotline in 2006. In July of 2008, we reported 
that these allegations were accurate. Specifically, 14 audits 
of 3 California locations we found did not meet professional 
audit standards.
    In our second report issued last month, we found that 65 of 
the 69 engagements that we reviewed also did not meet 
professional standards. To date, DCAA has rescinded 81 audit 
reports.
    Our two reports and recent Inspector General (IG) reports 
clearly show widespread audit quality problems. Key themes from 
our two reports include, as everyone has mentioned here, the 
lack of independence, insufficient audit work and removal of 
findings from draft reports by DCAA management without 
sufficient evidence.
    Examples of these issues include, first, contractor and 
buying command pressure resulted in a DCAA manager dropping 
adverse findings for a satellite launch proposal. The inspector 
general recently reported that this flawed audit may have 
resulted in the contractor recovering $271 million of 
unallowable cost.
    Second, DCAA issued an adequate opinion on a billing system 
with insufficient audit work. One auditor told us that testing 
was limited in this case, because--and I quote--``the 
contractor would not appreciate it.''
    And finally, another auditor wrote in a memo--and I quote 
again--``We are not holding this contractor with a history of 
questioned costs, poor internal controls and shoddy practices 
to a high standard by downgrading what are clearly significant 
deficiencies.''
    We have made 15 recommendations to DOD with the intent of 
strengthening DCAA's independence and effectiveness. One key 
recommendation is to develop a risk-based audit approach, 
focused on the quality of audits rather than the quantity of 
audits. We found audits of accounting and billing systems 
completed in two or three weeks. These audits often consisted 
of conversations with the contractor and a quick look at a few 
transactions.
    Further evidence of the need to cut corners is the 22,000 
reports issued in 2008 by DCAA's 3,600 auditors. That is 60 
reports issued every day of the year, including weekends and 
holidays. If all 22,000 reports are truly necessary, then 
clearly, 3,600 auditors is not enough.
    And I agree with Mr. Assad, what he said in our 
recommendations, for DOD to address this clear imbalance 
between resources and requirements.
    We reported contract management of weapons system 
acquisition as high-risk areas since the early 1990s. These 
high-risk areas leave hundreds of billions of dollars 
vulnerable to fraud, waste and abuse. I have Mr. Bill Woods 
with me today, who would also be available to answer any 
questions you have on our past high-risk work.
    In conclusion, our longstanding high-risk areas highlight 
the importance of strengthening DCAA's audits. I believe the 
DCAA has thousands of good auditors that have been trapped in a 
bad system. Positive steps have been taken or are under way to 
address many of the issues. We look forward to working with 
this panel and DOD to help DCAA achieve its full potential.
    Mr. Chairman, I look forward to answering your questions. 
And that is my statement.
    [The prepared statement of Mr. Kutz can be found in the 
Appendix on page 78.]
    Mr. Andrews. Thank you very much. I thank each of the 
witnesses, and we will begin with the questioning session.
    Mr. Kutz, I want to go back and talk about these hotline 
examples that came up. It is my understanding that in July of 
2006, there were reports at--was it several offices? Or was it 
only California?
    Mr. Kutz. There were three offices in California, 
primarily.
    Mr. Andrews. So, three offices in California. And the GAO 
wound up reporting about these examples. I guess last year was 
the report?
    Mr. Kutz. In July of 2008 was the report, and then the 
Senate had a hearing on that in September of last year.
    Mr. Andrews. And is your testimony that you looked 
initially at 14 audits, and each one of them failed to meet the 
standards of professionalism that you would articulate?
    Mr. Kutz. That is correct.
    Mr. Andrews. And you said 65 to 69 engagements. What does 
an engagement mean in this----
    Mr. Kutz. In the second report we issued, which was a 
broader look, I believe 40 or 50 of them were considered 
audits. The other ones were not characterized as audits meeting 
government auditing standards. They were still important work, 
but we called them engagements. That includes mostly audits, 
but some other not-audit engagements also.
    Mr. Andrews. And you have given us some illustrative 
examples of the weaknesses here, that the work papers did not 
support the conclusions frequently. Is that one of the 
examples?
    Mr. Kutz. Yes. And in fact, related to that I mentioned the 
changing of the opinions, too, where management would go in. 
And there would be, let us say, eight significant findings, and 
they would basically get rid of all the findings and issue an 
adequate opinion without any additional work. And you mentioned 
that, I think, in your opening statement.
    Mr. Andrews. Is it fair to characterize it, then, that some 
of the audit conclusions were just not supportable by the work 
papers? And then others, the work papers actually, took you in 
a different direction, and that the agency should not have 
reached the conclusion that it did. Is that----
    Mr. Kutz. I would say those are both true, yes----
    Mr. Andrews. Okay.
    Mr. Kutz [continuing]. In some of the cases we looked at.
    Mr. Andrews. You used, I think, an interesting phrase a 
minute ago, that we have thousands of good auditors trapped in 
a bad system. And I would take that as a premise from which we 
would start.
    I mean, I assume that the vast majority of the 4,400 
employees and 3,600 auditors are very highly ethical people who 
are trying to do the right thing for their country. I would 
just start with that as a presumption.
    But I would then want to look at why we have this 
deficiency that was reported here. I mean, it strikes me that 
there would be a standards problem, which is to say that the 
auditors are being asked to not do the wrong thing, but the 
standards that are governing their work are not the right ones. 
And that would go to this quantitative issue rather than 
qualitative.
    The second would be that there is a competence problem, 
that people want to do the right thing, but don't know how to 
do it. And then the third would be a motivation problem, where 
perhaps some of the people don't have the right motivation.
    If you were to look at that threesome of causes, which one 
is the predominant cause of the problems that you found on the 
hotline investigations that you did?
    Mr. Kutz. Well, the overall problem, I think, is the 
production environment, trying to issue 22,000 reports or 
30,000 audits with 3,600 people. And that leads to inadequate 
auditing.
    In some of the cases, it may have led to management trying 
to--I will use the word ``whitewash.'' These reports got 
whitewashed, basically, these reports, because it is quicker to 
get a report out with no issues and no findings than it is to 
get one out that has a ton of findings.
    Mr. Andrews. Is it fair to characterize your conclusion 
that there is too much of a quantitative emphasis, you have to 
get ``X'' number of audits out, rather than an emphasis on the 
quality of the audits that you do? Do you think that is a fair 
statement?
    Mr. Kutz. It was a requirement, and it was something that 
was built into the performance standards for staff. And so, 
there was a lot of pressure.
    And, you know, the public accounting world--I think we have 
another accountant here, too--you know, eating hours, working 
on weekends and not charging the time actually to the job, so 
it makes it look like the job costs less than it really did, 
which creates a cycle the next time someone comes back to do 
that audit. It took 200 hours, but it really should have taken 
300, because they worked weekends and late nights, and didn't 
charge the actual cost----
    Mr. Andrews. Now----
    Mr. Kutz. So it created that kind of an environment.
    Mr. Andrews. Mr. Assad and/or Ms. Stephenson, do you agree 
or disagree with that characterization of the environment in 
which the auditors are operating?
    Ms. Stephenson. I can address this, Shay.
    Yes, I do believe that there were a considerable number of 
pressures put on DCAA with the advent of acquisition reform in 
the mid-1990s. There was certainly the auditor's need to do it 
cheaper, faster. And that was something that we heard at all 
levels within the organization, and it was something that was 
supported within the department as well.
    Part of it is, we do need to get the audits quickly to 
contracting officers. I think what happened in that instance, 
then, we were not putting the sufficient hours on the 
assignments. And often, what got compromised was the 
documentation.
    Mr. Andrews. Do you agree with the hypothesis that 60 
audits a day couldn't possibly be done in a high level of 
quality by personnel this size?
    Ms. Stephenson. Yes and no. The reason I say ``no'' is, 
many of those assignments are quite small. It might be a 40-
hour assignment to review a $10,000 interim progress payment on 
a fixed-price contract. They are not all a multibillion-dollar 
Logistics Civilian Augmentation Program (LOGCAP) proposal, 
which would take thousands of hours. So, there is a mix.
    And I think when you look at, if we were to take all the 
small assignments and all the low-risk assignments, such as 
what we have done for 2010, in which we will not be doing a 
great many of those, and looking at the higher risk, there is a 
vastly reduced number of assignments.
    At one point, this agency was doing 35,000, if not up to 
40,000 assignments. We have now made that down to about 25,000, 
now probably to 20,000. So, just in the last year or so of not 
performing some of these low-risk assignments to put the effort 
into the high risk, we are performing fewer assignments.
    Mr. Andrews. I am sorry, Mr. Assad, what do you think? Do 
you think that the culture in which the agency has been 
operating over-stresses quantity of audits done to the 
detriment of quality?
    Mr. Assad. I think that there is a tremendous pressure to 
get contracts awarded. And in some cases for good reason. I 
mean, we are at war. We need to get this equipment to our 
warfighters. On the other hand, you know, we have got to get a 
good deal for the taxpayers. So, one of the things that we are 
doing with DCAA----
    Mr. Andrews. If I may, though, is your answer ``yes'' or 
``no''? Do you think that the environment in which the agency 
is operating is unduly slanted toward the quantity, or not?
    Mr. Assad. I think it is, yes, the environment is one that 
stresses timeliness.
    Mr. Andrews. Okay. I am going to yield to the senior 
Republican, Mr. Conaway, for his questions.
    Mr. Conaway. Thank you, Mr. Chairman.
    What happens to a contract officer who can't get an audit 
on time? Do we put those into a special higher risk category? 
In other words, if you can't get the report done, and the 
contract officer needs to move forward with the contract, do 
our systems put that into a higher risk category that we follow 
up with later in a different regard?
    Mr. Assad. I think two things happen, Mr. Congressman. Most 
times, it just means that the contract award is delayed. 
Because, you know, there is only a small number of our 
contracting officers percentage-wise who can actually move 
forward without the assistance of a DCAA audit, who would have 
the skills and the capability to be able to go forward and 
still get a fair deal for the taxpayer.
    So, most of the time, it results in a delayed award. And in 
those cases where----
    Mr. Conaway. Well, is that an inadequacy in training for 
the contracting officers?
    Mr. Assad. Oh, yes.
    Mr. Conaway. Okay.
    Mr. Assad. You know, no doubt about it.
    Mr. Conaway. April, you know, one of the allegations is 
undue pressure from the top from, you know, partners, in 
effect, on the managers. What are you doing to address that? 
Because that is systemic to public accounting firms everywhere. 
What are you doing to address and protect the auditors from 
upper management, so to speak, in these issues where you have 
got overrides that occur?
    Ms. Stephenson. Sir, there are two things that we are 
doing. First, everyone was under the pressure with the prior 
metrics that we had had in place that were supported by the 
Department. Those metrics were changed in September of 2008. 
Those metrics were based on productivity, hours per assignment, 
et cetera.
    We completely removed all of those. So people do not have 
the budget hour constraints. We removed from the performance 
plans the requirement to meet budget hours. We have given the 
staff the hours that they need. And we have emphasized you need 
to take the hours necessary to do a complete audit, even if it 
means one versus three for that particular month.
    So we have tried to reiterate the highest level down to the 
lowest level by removing it from the performance plan, removing 
the metrics. Budget hours will no longer drive these 
assignments. Quality will drive them. We have put more metrics 
in related to quality.
    Number two, we have put in a place a Web site, anonymous 
Web site in which employees can file complaints with us when 
they feel that findings have been removed or other issues have 
happened. We have an active program on that in which we will 
set up an investigation for every complaint and assess whether 
that indeed has happened.
    Mr. Conaway. Yes. How often has that been used so far?
    Ms. Stephenson. It has been used quite frequently since we 
have set it up.
    Mr. Conaway. Okay. That is meaningless to me. How many 
numbers? How many times?
    Ms. Stephenson. I am going to guess that we have probably 
had 400, at least.
    Mr. Conaway. Okay. One of the GAO's allegations is that 
failure to meet general accepted governmental accounting 
standards--or auditing standards. Excuse me. There are 3,600 
auditors. How many training hours are they provided each year?
    Ms. Stephenson. We are required under the auditing 
standards to meet every 2 years the 80-hour requirement for 
continuing professional education and at least 20 hours every 
year in accounting. We far exceed that.
    Mr. Conaway. Accounting or auditing?
    Ms. Stephenson. In auditing. I am sorry. In auditing.
    Mr. Conaway. Okay.
    Ms. Stephenson. We far exceed that. I think our average 
hours that people have in training----
    Mr. Conaway. You track those requirements?
    Ms. Stephenson. Absolutely. We have an entire training 
system that tracks by class, by type of assignment.
    Mr. Conaway. Who provides the training?
    Ms. Stephenson. A vast majority of the auditing training, 
the technical auditing training, is provided by DCAA through 
our Audit Institute in which we have course developers and 
instructors. And we also have on staff education specialists.
    Mr. Conaway. Yes. Are those--I mean, you are training 
yourself, and you are providing your own training--are you in a 
loop where the, you know, where the problems with the training 
is not adequate so that the folks being trained don't get the 
right kind of training? Are you----
    Ms. Stephenson. That is definitely a concern. And when the 
GAO issued the report in 2008, we did a--we are in the process 
of completely revamping the training to ensure that we are 
providing the training that we need to. We are consulting with 
the Inspector General (IG) and, when necessary, with the GAO to 
ensure that we are getting the type of training that we need to 
our people so there isn't that loop of people that didn't learn 
how to do it right are now training people not to do it right.
    Mr. Conaway. Right. Right.
    Ms. Stephenson. That is a concern.
    Mr. Conaway. Mr. Assad, you mentioned there is yet a panel, 
a panel that is the subcommittee that is working on looking at 
some of these recommendations. What is the timing for their 
report?
    Mr. Assad. Well, we usually come out once a quarter with 
recommendations. I think it is going to take us about 6 months 
because we are really focusing on two different things. The 
first is the evaluation of business systems, which is a problem 
where we have DCMA responsible for the overall cognizance of a 
business system. I mean, DCMA and DCAA doing the auditing. We 
need to reconcile that.
    And the second is this whole issue of risk-based auditing. 
You know, how many audits should we be doing? What is the 
quality of those audits? Do we really need DCAA to be doing all 
this work? And how do we focus them in an area, from a customer 
point of view, to a more focused work establishment.
    Mr. Conaway. Yes.
    Mr. Assad. I would say about 180 days.
    Mr. Conaway. Okay.
    Mr. Kutz, is the director of DCAA report high enough up in 
the food chain at DOD to protect it from whatever it needs to 
be protected from?
    Mr. Kutz. I can't answer that fully. I mean, one of the 
things that the Senate had asked us to do was to provide 
alternative organizational placement options. We weren't for or 
against them. We just put them out there as either elevating 
them in the organization or possibly moving it outside of DOD 
and having some sort of government-wide audit agency. But we 
didn't really study those in depth. We laid out some pros and 
cons.
    Mr. Conaway. Okay.
    Mr. Kutz. But that is a potential issue.
    Mr. Conaway. Yes. Okay.
    Ms. Stephenson, one final thing: audits. I know your 
testimony said you guys covered $330 billion in costs, 10 
percent error rate. Is that an expected error rate?
    Ms. Stephenson. Yes, that is about what we run. I think if 
we were to take the contractor bid proposals--those are the 
ones we do before award--it is actually higher than that. It is 
probably running about 15 percent on average that we have 
questioned in bid proposals.
    Mr. Conaway. Okay. That is a startling number that we would 
have 10 percent--we will call it waste rather than fraud--but 
10 percent. Will you follow up on the $32 billion findings 
here? What ultimately winds up happening with that $32 billion?
    Ms. Stephenson. In the first part of it, which was the 
contractor bid proposals, that is what the contracting officer 
is going to use to negotiate the price.
    Mr. Conaway. Okay, so it is not necessarily a dollar?
    Ms. Stephenson. No. Where we have the vast majority of our 
findings or the actual dollars associated with them are before 
contract award. After contract award we probably have about 5 
to 8 percent related to the findings. On contractor business 
systems we are running right now where we have got at least one 
segment of the top 100 defense contractors one location.
    A Lockheed Martin, for example, may have multiple 
locations. But of all those, at least of the top 100, 69 
percent have one location with at least one deficient system, 
to put some perspective on it. But our dollar savings comes in 
the vast majority prior to contract award.
    Mr. Conaway. So afterwards we are--okay. That----
    Ms. Stephenson. After contract award we are----
    Mr. Conaway. How much can you bifurcate your workload 
before contracts are signed versus follow-on auditing to make 
sure it was done correctly?
    Ms. Stephenson. That is right. We do. We do about half of 
it. The cost reimbursable contracts are primarily what we 
review after contract award.
    Mr. Conaway. Okay.
    Ms. Stephenson. And that would be ensuring that the 
business systems, earned value management systems, those type 
of things are in place to ensure that we are not being 
overcharged throughout the contract process. That is about half 
of the audits that we do are prior to contract award.
    Mr. Conaway. And your expected error rate in that regard 
is?
    Ms. Stephenson. Is about five to eight percent.
    Mr. Conaway. Okay. And you theoretically would allow 
somebody a five--the system allows people to continue having an 
eight percent error rate year after year? Or how does that 
work?
    Ms. Stephenson. No, we would hope not. In fact, this is one 
of the areas----
    Mr. Conaway. Hope is not a real good credit----
    Ms. Stephenson. Well, what I would say is with the business 
systems----
    Mr. Conaway [continuing]. As we have seen.
    Ms. Stephenson [continuing]. For example--and I am sorry to 
be doom and gloom, but this is one of the areas that we had 
addressed with the Commission on Wartime Contracting--is 
oftentimes we will report a contractor business system as 
inadequate. In fact, we had had some that were several years of 
inadequacies that continued and not a lot was done.
    And that is an issue that this new subcommittee that has 
been set up by Mr. Assad is going to look at, is what is needed 
both within the regulations and the statute to strengthen the 
contracting officer's ability to make things such as an interim 
withhold on payments to be an incentive for contractors to fix 
these systems. That is one of the challenges that I have 
mentioned in my testimony, is that contractors have not had a 
lot of incentive to correct these systems. So we have issued 
reports, and not a lot may happen to them.
    Mr. Conaway. Okay. Well, the best lines an old audit 
partner I heard said that it is about a photographer. And the 
photographer said if you want a prettier picture, you have got 
to bring me a prettier face. So the fact that you are, you 
know, telling us things that are wrong with the system is--you 
know, we are not going to shoot the messenger because the----
    Thank you, Mr. Chairman.
    Mr. Andrews. Thank you.
    The gentleman from Indiana, Mr. Ellsworth, is recognized.
    Mr. Ellsworth. Thank you, Mr. Chairman.
    Ms. Stephenson, can you tell me what triggers the pre-award 
audit versus the post-award audit? Is it dollar amount? Is it 
new contractors? What actually triggers if you do a pre-award 
contract?
    Ms. Stephenson. The pre-award is----
    Mr. Ellsworth. Or audit contract.
    Ms. Stephenson [continuing]. Is governed by two aspects. 
First is primarily the contracting officer's request for an 
audit. What will trigger their request for an audit is the 
submission of cost data from a contractor. And I will give you 
an example.
    In a sole source negotiated procurement, the regulations 
would call for the submission of cost data. In that case, we 
would be involved in performing an audit, given a dollar 
amount. It is $10 million cost-type. That is the threshold. And 
for fixed price it is $650,000.
    For procurements in which there is no cost data such as the 
competitive and the commercial item procurements, we would 
generally not be involved. I say generally. It is very rare 
that DCAA would be involved when there is not the submission of 
cost data. So that is what would trigger the bid proposal, a 
contracting officer request and cost data.
    After contract award under the regulations, it is the cost 
reimbursable contracts. And in that case, there is no 
threshold. We do an annual audit of all contractors that have 
cost reimbursable contracts. We audit the costs for those 
years, whether it is a $10,000 contract or $1 billion contract. 
Regarding business systems, we only audit the business system 
at the largest contractors, those that have $100 million or 
more of cost-type contracts in a given year.
    Mr. Ellsworth. Thank you very much.
    Mr. Chairman, in 2004, 2005, I was sitting at home before I 
ever thought about running for Congress. And I was reading an 
article that was talking about defense contractors that didn't 
pay their--their federal income tax. And that kind of shocked 
me, sitting at my kitchen table, that they continue to get 
defense contracts even though they weren't paying their taxes.
    I know we all hate to pay taxes. But it is a necessary 
evil.
    One of my first meetings with Mr. Kutz when I came to 
Congress was about this. And the report said that in 2005 
33,000 civilian agency contractors owed over $3 billion in 
unpaid taxes. In 2004, same 27,000 owed over $3 billion in 
taxes and yet continued to receive federal contracts.
    I think, Mr. Kutz--and correct me if I am wrong--when we 
sat in our meeting, I asked why we would award contracts to 
people who weren't paying their fair share of their taxes. And 
it was not you. It was somebody else in the room said that some 
were hoping that they would pay the taxes from the first 
contract with the second contract profits. Didn't seem like 
good business sense to me.
    But I guess my question to you is--and thank you very much 
for your work--is it getting any better since our meeting? I 
filed some legislation to try to prevent this. It died in the 
Senate, or there was no action in the Senate. I filed that 
again. But have you seen any improvement since we talked and 
going into now 2006, 2007 and 2008?
    Mr. Kutz. No, I don't think so. And it is interesting that 
you mention that. And Ms. Stephenson mentioned five to ten 
percent before. But about six percent of government contractors 
have known tax problems. So it is not a small issue. And it 
still continues.
    Most of the efforts are done on the back end levying 
payments, as you mentioned, the logic being, of course, well, 
let us keep giving them money so that they can actually pay the 
taxes that they already owe us versus preventing them from 
paying taxes. So more of the effort has been on the back end, 
not a whole lot on the front end.
    Mr. Ellsworth. Have we done anything about the resources to 
the disbarment list from--about giving to increase, to pay 
closer attention to the disbarment list or done anything, any 
improvement in that area?
    Mr. Kutz. Not with respect to taxes because the Internal 
Revenue Service (IRS)--I mean, people can't get information on 
taxpayer problems like that. That is something that can't be 
shared across agencies. Section 6103 of the Internal Revenue 
Code does not allow IRS to share that with the Department of 
Defense, for example. So even when we did our investigations, 
we couldn't tell the Air Force and Army who the tax cheats were 
that we had investigated.
    Mr. Ellsworth. Mr. Chairman?
    Thank you, Mr. Kutz.
    Mr. Chairman, as complex as this issue is that we are 
studying--it has been going on for years--this seems like one 
that we could almost simply take care of, of not letting people 
who aren't paying their taxes participate in the procurement 
system. And like I said, we will continue to work on that. 
But----
    Mr. Andrews. If the gentleman will yield? As we discussed 
before, the intention of the committee is to spend time in 
December and January meeting among the members to discuss ideas 
for legislative recommendations that we would forward to the 
full committee and then, frankly, to the leadership because 
there would be some jurisdictional issues here.
    I would encourage you to bring that up during those 
discussions. I have made a note of it now. But I would be 
strongly inclined to include your recommendation in our report 
and try to get it enacted.
    Mr. Ellsworth. Thank you. I would yield back.
    Thank you all, the witnesses.
    Mr. Andrews. The gentleman from Colorado is recognized.
    Mr. Coffman. Thank you, Mr. Chairman.
    First of all, I am stunned.
    I think, Ms. Stephenson, you had mentioned that there is 
little leverage when a contractor isn't performing, when the 
audit shows the contractor isn't performing in terms of interim 
steps, withholding payment in order to get contract compliance. 
Could you elaborate on that?
    Ms. Stephenson. Yes. When it comes to the business 
systems--and I will give you an example--let us take the system 
that is used for preparing billings to the government. We refer 
to that as the billing system. If we find that there are 
deficiencies, and a common deficiency that we often find is 
that the billing has costs that are either in excess or in non-
compliance with the contract terms and conditions; the 
contracts may have their own unique terms and conditions, which 
sometimes are not caught by contractors when they bill costs. 
That is a common finding.
    In those instances, contractors will submit a corrective 
action plan. And oftentimes--and I would say probably most, if 
not all the time--the corrective action plan itself is often 
viewed as enough versus saying does this corrective action 
plan--do we need to do something in the meantime for this 
contractor to have an incentive to put this plan in place. 
Sometimes plans come in 6 to 12 or if not more after the 
deficiencies have been reported.
    During that period of time, we think that there needs to be 
some leverage. There needs to be some withholdings to 
incentivize a contractor to put those actions in place a whole 
lot sooner because in the meantime that system is still 
vulnerable to overpayments to the government.
    What we have done in those instances is we don't permit the 
contractor to submit billings directly to payment offices. They 
must come through DCAA, in which we will then review those 
interim payments to ensure that that problem is not continuing.
    Mr. Coffman. Okay.
    Ms. Stephenson. And we think there does need to be 
incentives. And as I said earlier, Mr. Assad completely agrees 
with this and has quickly set up this subcommittee to assess 
what more can be done in the interim.
    Mr. Coffman. Okay.
    Would anybody else like to respond to that? Okay.
    It would seem that on a fixed price versus a variable or a 
cost plus contract that the auditing requirements would be much 
less than you are really auditing on the basis of outcome in 
terms of meeting those performance metrics. But it seems that 
when you are in a variable cost structure in terms of 
contractual arrangement, that has got to be pretty tough 
because you are measuring inputs and as well as making sure 
that they achieve the outcome.
    Has there been a trend in either direction? It would seem 
to me that we ought to move to fixed price whenever possible.
    Mr. Assad. Mr. Congressman, it is actually a little bit of 
the opposite way. When we get fixed price contracts, we need 
more audit assistance because at that point once we decide on 
what the price is, there is no more recourse for the taxpayers. 
We are going to pay that price. And if there is a disparity 
between what we have agreed to and the value we are getting, 
the taxpayer has no recourse.
    In redeterminable type of contract, on the other hand, if 
there is some incentive for the contractor to actually under-
run the contract, yes, it does require post-contract award 
administration. But, in fact, the taxpayer is going to get a 
little of that money back. And one of the things that we are 
looking at right now while there is certainly a desire for the 
department to move to fixed price contracting when we can, in 
those instances where we are not satisfied that the fixed price 
is going to, in fact, provide value to the taxpayers, we are 
going to revert to a fixed price incentive contract where it is 
redeterminable.
    It says, look, we are just not happy that we are getting a 
good deal for the taxpayers. So we are going to establish a 
ceiling price. And then underneath that price we are going to 
share it. And so, that, in fact, may even add to DCAA's 
workload a little bit. But we have got an issue with, you know, 
our ability to ensure at the outset of this committee hearing--
to ensure that the price we are paying and the value that the 
taxpayers and warfighters are getting is fair and reasonable to 
the taxpayers.
    And so, you know, it is a problem. And, in fact, again, in 
fixed price contracting we require more audit services.
    Mr. Coffman. Thank you, Mr. Chairman. I yield back.
    Mr. Andrews. Thank you, Mr. Coffman.
    Mr. Cooper is recognized.
    Mr. Cooper. Thank you. I love the troops, but we have to 
recognize that year in, year out the Department of Defense is 
considered by both the Treasury Department and GAO to be the 
least auditable of all government agencies. It dramatically 
falls short even of the standards set by some of our other 
agencies that have been non-compliant. And in war time you 
might make excuses. But this has happened year in, year out.
    Here we are focusing just on the procurement side of 
things. And the news is really no better. To have an error rate 
of 64, 69, you know, approximates like 93 percent flaws, 
mistakes, problems. And this is a field that is pretty well 
circumscribed.
    My friend from Texas knows better than I there are 
traditional rules that auditors are supposed to obey: 
independence, all the criteria. And for those to have been 
flouted in so high a percentage of cases is truly amazing. And 
to have findings hidden or obscured or lost is truly stunning.
    So I am wondering if hiring 700 new people in an 
organization like this is helpful or that is just going to 
create more problems. Everyone who testifies before Congress 
promises to do better. And, you know, this is an agency that 
has been in place since 1965.
    So I am wondering about a lot of the issues, including it 
almost seems like some of these audits are kind of like a 
doctor that only can get a health report by doing an autopsy. 
It is too late. You know, maybe we need folks who are embedded 
in these large organizations because, as my colleague from 
Indiana pointed out, the simple fact of tax non-compliance is 
stunning. And yet we have found ourselves in such red tape, we 
are not even able to find out the facts on that. So maybe we do 
need to amend Section 6103.
    But given 144 previous reports on reforming Pentagon 
procurement since World War II, almost none of which have been 
successful, the challenge for this panel is to take up new 
solutions, come up with something that really might be 
effective instead of repeating the high error rate of 
congressional reforms in past years. We issue a report. You 
people look at it. Nothing changes. And we keep on wasting 
taxpayer dollars.
    That is not the answer I want to see. So I would like to 
encourage each one of you to help us think of new solutions, 
not just hiring more people. In most bureaucratic circles being 
able to expand your payroll a significant percent like 20 
percent would be a sign that, hey, the organization is growing 
and successful. Well, in this case, it is a troubled 
organization that needs all sorts of help.
    Now, perhaps there are, you know, reporting problems or 
other bureaucratic things getting the boxes right so that the 
Pentagon pays sufficient attention or so that you have the 
resources or the independence so you can be more authoritative. 
But the basic blocking and tackling today seems simply not to 
be done.
    And I think that the taxpayers deserve a better deal. But, 
you know, in a bureaucracy everyone wants to keep their job. No 
one wants to be punished.
    And I would like to ask Ms. Stephenson: What is your 
dismissal rate in your department for problem auditors or 
problem audits? What disciplinary actions have you taken within 
your ranks to encourage better performance? What sort of 
training programs do you have to make sure that people know and 
follow real auditing standards instead of giving these defense 
contractors a slap on the hand and a little gold star that 
contradicts the findings of the audit that has just been 
conducted? So what really is going on inside your agency?
    Ms. Stephenson. Let me first address the issue of the 700 
employees over the next 3 years. We recognize that is only a 
piece. Throwing more auditors solely at this issue is not the 
solution. And we don't say that that is the solution.
    It has to be a complete revamping of how we perform the 
audits, what our work paper requirements are, what the 
requirements are when there is a disagreement over audit 
findings, how we address our quality assurance organization, 
which had been getting a clean opinion on our peer reviews from 
the IG for some time, how we revamp each piece in the DCAA 
chain.
    And I don't mean just management. I mean each piece of how 
we perform our audits, how we interact with contractors, how we 
get access to records, how we interact with contracting 
officers. Each piece of that has had to have been addressed and 
is being addressed.
    We also had to address our training. We had to address the 
infrastructure of DCAA to say what broke down in these 
processes.
    Mr. Cooper. Excuse me. My time is running out. How many 
auditors have you let go for incompetence?
    Ms. Stephenson. I do not know, sir. But I would be happy to 
get that data and enter it for the record.
    [The information referred to can be found in the Appendix 
on page 97.]
    Mr. Cooper. Thank you.
    Thank you, Mr. Chairman. I see my time is expired.
    Mr. Andrews. Thank you, Mr. Cooper.
    Mr. Conaway, any closing remarks or follow-up?
    Mr. Conaway. Well, I do have some follow-up questions, if 
you don't mind.
    Mr. Andrews. Sure.
    Mr. Conaway. Mr. Kutz, have you been requested to do a 
follow up at some point in time on your recommendations for 
DCAA?
    Mr. Kutz. Not formally at this point. Certainly, we will 
continue to work with the Senate committee. And we would be 
happy to work with you also. I am sure that they would have no 
problem jointly working with you on these matters. I am certain 
of that.
    Mr. Conaway. Okay.
    Ms. Stephenson, Mr. Assad, who sets the budget for DCAA?
    Ms. Stephenson. It goes through the Office of the Secretary 
of Defense.
    Mr. Conaway. Okay. But Bob Gates says that is enough money 
for you?
    Ms. Stephenson. You know, to be honest, I am not sure, once 
it leaves the comptroller's office, how all that comes into 
Congress.
    Mr. Conaway. Okay. Right. So part of where DCAA shows up in 
the org chart is that review.
    And Mr. Assad, I hope, would say that whoever that person 
is has the right authority to say that they are getting the 
right allocation of resources.
    Mr. Assad. Yes, I believe it is accurate to say that Under 
Secretary Hale is responsible for establishing the budget for 
DCAA.
    Mr. Conaway. And so, part of your committee findings will 
decide if whether or not that is for under secretary or--I 
don't know what all the layers are of where that is in the----
    Mr. Assad. No, I----
    Mr. Conaway. But the point is is if the person who has got 
ultimate responsibility for deciding what the budget of the 
DCAA should be doesn't have enough stroke in the overall 
system, then it will be under-resourced.
    Mr. Assad. I think Under Secretary Hale of the comptroller 
is, from my personal opinion as well as the department's 
opinion, is that organizationally DCAA is properly placed under 
his auspices.
    Mr. Conaway. Mr. Kutz, what are the auditing standards that 
are missed? I mean, I spent 7.5 years on a state board of 
accountancy. And we had a constant flow of CPA firms who have 
come through the system who had failed to confirm receivables 
or, you know, confirm bank accounts, those kinds of things. Can 
you give us a sense of what these failed audits--what auditing 
standards were not adhered to?
    Mr. Kutz. Well, primarily the sufficient, competent 
evidential matter necessary for an audit. For example, if you 
are testing a system--and we saw this a lot--they might be 
looking at a one-year period and may have picked one or two 
transactions from one day, sometimes that the contractor even 
selected for them, and then gave an opinion on a system over a 
whole period of time. So that clearly doesn't meet sufficient, 
competent evidence standards for giving an opinion on a system.
    Mr. Conaway. Ms. Stephenson, how does that occur? I mean, 
you and I both know that is enough work to be done to support 
an opinion like that. How do you determine those levels of 
testing?
    Ms. Stephenson. Yes, the transaction testing and work paper 
documentation were the two primary areas in the auditing 
standards in which we had the difficulties with. In some 
instances, there were a few in which they had tested a few 
transactions during the actual billing system audit and had 
used testing that was done in other assignments of contractor 
costs to augment the testing within that particular assignment.
    I am not saying that is right or wrong. That is what 
happened.
    Mr. Conaway. Okay.
    Ms. Stephenson. We no longer do that. We are now requiring 
the testing on a billing system to be done within that billing 
system assignment.
    Mr. Conaway. The timeline for analysis, the risk-based 
management, risk-based auditing focus is what?
    Ms. Stephenson. We have instituted that right now. That 
started in October of 2010.
    Mr. Conaway. And we will determine later whether GAO 
believes that is the right model. I mean, Ms. Stephenson, quite 
frankly, to have a system that allows one transaction to be 
tested and then you issue an audit opinion on that, to allow 
that to go forward, then to have the same group of people tell 
us that they now have the right risk-based auditing standards 
in place--you know, it is a trust and verify thing. So I am not 
real comfortable with the statements that, you know, we have 
now put in a risk-based auditing system, because it is the same 
people who decided that one transaction was okay.
    Ms. Stephenson. Well, one transaction didn't happen very 
often----
    Mr. Conaway. But then that is an anomaly, but 
nevertheless----
    Ms. Stephenson. But what I will say to you that we did is 
we stopped the manner in which we have previously done system 
reviews. We have completely revamped it. And part of this risk-
based approach that we announced on October 1st is we are not 
going to start any system reviews this year until we have the 
revised guidance out in the field. That process is being pilot 
tested right now in which we will look at significantly more 
transactions across the entire system.
    And we are working with the IG to ensure that that process 
will indeed meet the auditing standards. So, yes, you are 
right. And in looking at this to say, well, how can I give you 
assurance that isn't going to continue this year. It is because 
I have stopped it.
    Mr. Conaway. Okay.
    Ms. Stephenson. And I have issued it to the workforce 
saying we are not going to do them until I give you revised 
guidance that has the sufficient testing necessary to express 
an opinion on these systems.
    Mr. Conaway. Okay. You mentioned quality assurance system 
with DCAA. Can you briefly describe that to us?
    Ms. Stephenson. Our quality assurance organization has two 
parts. One, we use the DOD Inspector General to perform our 
peer reviews, which are done on a three-year basis. Every three 
years it will look at three years' worth of audits that we do.
    Mr. Conaway. Yes. Why would you not use senior management 
within the other offices to audit? You know, in public 
accounting firms, one of the things that we did was we had 
audit partners from one office audit the work that was done 
within the firm by other auditors. I mean I don't--go ahead. 
Why don't you discuss this?
    Ms. Stephenson. That is right. We have two pieces. One is 
the external, which is what the DOD Inspector General does for 
us. The other piece is internal, which is we have a separate 
Assistant Director for Quality Assurance at our headquarters 
that performs quality assurance reviews across the agency.
    Mr. Conaway. Okay. And that person is new?
    Ms. Stephenson. That person is a senior executive.
    Mr. Conaway. No, no, no. We have a new person there, given 
the problems we have had with the systems?
    Ms. Stephenson. Yes, that person is new and has just been 
put in place this month.
    Mr. Conaway. The position is just put in place, or the new 
person has been in place ?
    Ms. Stephenson. Both. We had the position at a 15 level, 
and we had it performed by each of our regions. Regions would 
be similar to the partners----
    Mr. Conaway. Right.
    Ms. Stephenson [continuing]. In a firm. Each of the regions 
performed reviews of other regions, and it was more 
decentralized. We in 2008 brought that up to the headquarters 
level and stood up a new division in which I filled the 
position last year, but I have got it an Assistant Director 
senior executive position now.
    Mr. Conaway. Okay. Is this person in a position that if Mr. 
Kutz or his follow-on folks bring us a GAO report that looks 
like the one we just got, that person would be fired?
    Ms. Stephenson. I don't know if they would be fired. I mean 
the reason I say that is I don't know if it was during their 
timeframe. We would have to say whether these assignments 
happened during their timeframe.
    Mr. Conaway. Yes, that is fine, but I am just saying if 
under that person's tutelage, the system doesn't get any 
better.
    Ms. Stephenson. I would certainly say if we don't catch 
these areas ourselves and instantly correct them, yes.
    Mr. Conaway. Okay.
    Mr. Assad, elevating the DCAA's findings and 
recommendations that would actually have some teeth and prevent 
these going on--what are you going to do to elevate those 
findings so that either we keep track of them from the 
congressional side or the system itself uses that data and 
information to actually improve the process?
    Mr. Assad. Well, we are going to provide you a report on an 
annual basis to Congress on the findings of the Contracting 
Integrity Panel, so you will know exactly what it is that we 
are recommending and exactly the action--including there will 
be the action plans as to when we will put in place.
    Mr. Conaway. Okay.
    Mr. Chairman, just one final comment on Mr. Cooper's 
earlier comments. This year's Defense Authorization Act--the 
House attempted to accelerate the timeframe in which the DOD is 
auditable from 2017 to 2013. And our colleagues on the other 
side of the building were a lot more lenient than what our 
position was, and somehow we wound up with the lenient version 
in this year's round.
    This is an important issue, auditing across the entire 
system, not just the auditing work Ms. Stephenson and her team 
does, and we are going to continue to shine a light on it, 
because this is important to the system, so----
    And I yield back.
    Mr. Andrews. If the gentleman would yield, I would say to 
him what I said to Mr. Ellsworth. I certainly would want that 
recommendation included as part of this panel's report, that if 
anything, the hearing today and the other work that we have 
done points out the compelling need for a systemic audit of the 
Department of Defense as soon as practicable. And I think that 
is an issue that we should revisit very aggressively. I agree 
with you.
    Mr. Conaway. And I would also recommend that we somehow 
work our side of the system to make sure that the GAO comes 
back on a follow on behind the DCAA audits that they have 
already done.
    Mr. Andrews. I agree, and I just want to sum up this 
morning with that in mind, that the panel will consider the 
evidence that we have derived from these hearings over the 
course of the next three months or so, and we will meet among 
the members of the panel and discuss recommendations that we 
have and generate for public review a series of policy 
recommendations which, if adopted by the panel, would then be 
forwarded to the full committee for consideration as part of 
next year's reauthorization.
    Dr. Assad, we would certainly--Mr. Assad, excuse me--we 
would welcome the subcommittee that you are involved with, its 
recommendations, so we could evaluate them.
    Ms. Stephenson, any input you would like to give us we 
would like as well.
    And certainly, I want to formally extend to GAO our request 
for your recommendations, based upon the work that you have 
done, that we would then work with Senators Lieberman and 
Collins to find a common position. I would personally like to 
see those recommendations focus on altering the standards from 
standards which encourage an increase in the quantity of audits 
to those that increase the quality.
    We really shouldn't be surprised when we get a defective 
work product, if the organization is tilted toward simply 
getting the reports out. And I think that we need to track that 
question very, very closely.
    The record of the proceeding will remain open for anyone 
who would like to supplement any of their comments today. I 
know that there are a couple of questions pending for Ms. 
Stephenson that Mr. Cooper would ask. The same would go for the 
members.
    We appreciate everyone's involvement.
    And with that, the hearing is adjourned.
    [Whereupon, at 9:20 a.m., the panel was adjourned.]
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