[Senate Hearing 112-507]
[From the U.S. Government Publishing Office]
S. Hrg. 112-507
FOOD SERVICE MANAGEMENT CONTRACTS:
ARE CONTRACTORS OVERCHARGING
THE GOVERNMENT?
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HEARING
before the
AD HOC SUBCOMMITTEE ON CONTRACTING OVERSIGHT
of the
COMMITTEE ON
HOMELAND SECURITY AND
GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
OCTOBER 5, 2011
__________
Available via http://www.fdsys.gov
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and Governmental Affairs
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COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
JOSEPH I. LIEBERMAN, Connecticut, Chairman
CARL LEVIN, Michigan SUSAN M. COLLINS, Maine
DANIEL K. AKAKA, Hawaii TOM COBURN, Oklahoma
THOMAS R. CARPER, Delaware SCOTT P. BROWN, Massachusetts
MARK L. PRYOR, Arkansas JOHN McCAIN, Arizona
MARY L. LANDRIEU, Louisiana RON JOHNSON, Wisconsin
CLAIRE McCASKILL, Missouri ROB PORTMAN, Ohio
JON TESTER, Montana RAND PAUL, Kentucky
MARK BEGICH, Alaska JERRY MORAN, Kansas
Michael L. Alexander, Staff Director
Nicholas A. Rossi, Minority Staff Director and Chief Counsel
Trina Driessnack Tyrer, Chief Clerk
Joyce Ward, Publications Clerk and GPO Detailee
AD HOC SUBCOMMITTEE ON CONTRACTING OVERSIGHT
CLAIRE McCASKILL, Chairman
THOMAS R. CARPER, Delaware ROB PORTMAN, Ohio
MARK L. PRYOR, Arkansas SUSAN M. COLLINS, Maine
JON TESTER, Montana JOHN McCAIN, Arizona
MARK BEGICH, Alaska JERRY MORAN, Kansas
Margaret Daum, Staff Director
Brian Callanan, Minority Staff Director
Kelsey Stroud, Chief Clerk
C O N T E N T S
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Opening statement:
Page
Senator McCaskill............................................ 1
Prepared statement:
Senator McCaskill............................................ 21
WITNESSES
Wednesday, October 5, 2011
Phyllis K. Fong, Inspector General, U.S. Department of
Agriculture.................................................... 4
John F. Carroll, Assistant Attorney General, Office of the
Attorney General of the State of New York...................... 6
Charles Tiefer, Professor of Law, University of Baltimore School
of Law, and Former Commissioner, Commission on Wartime
Contracting in Iraq and Afghanistan............................ 7
Alphabetical List of Witnesses
Carroll, John F.:
Testimony.................................................... 6
Prepared statement........................................... 30
Fong, Phyllis K.:
Testimony.................................................... 4
Prepared statement........................................... 23
Tiefer, Charles:
Testimony.................................................... 7
Prepared statement........................................... 45
APPENDIX
Questions and Responses for the Record from:
Ms. Fong..................................................... 55
Mr. Carroll.................................................. 59
Mr. Tiefer................................................... 62
FOOD SERVICE MANAGEMENT CONTRACTS: ARE CONTRACTORS OVERCHARGING
THE GOVERNMENT?
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WEDNESDAY, OCTOBER 5, 2011
U.S. Senate,
Ad Hoc Subcommittee on Contracting Oversight,
of the Committee on Homeland Security
and Governmental Affairs,
Washington, DC.
The Subcommittee met, pursuant to notice, at 2 p.m., in
Room SD-342, Dirksen Senate Office Building, Hon. Claire
McCaskill, Chairman of the Subcommittee, presiding.
Present: Senator McCaskill.
OPENING STATEMENT OF SENATOR MCCASKILL
Senator McCaskill. I want to welcome everyone to this
hearing today. I have an opening statement that I will give.
I have to say, before I begin this opening statement,
though, that I am not shocked that this is not a full room. As
I began to prepare for this hearing today, I began to
understand the nature of the problem. This is really
complicated and hard, and it is precisely when something is
complicated and hard that bad things happen. Today, we seek
clear direction and transparency because that usually
translates into better accountability. And I think the lack of
accountability in this particular area can be traced directly
to the complexity of this issue.
So I am really glad that we have the three of you here
today. This is going to be one of those hearings that I talk
about a lot in this Subcommittee. That is, this subject matter
is, as you can tell by the room, not the sexiest in Washington.
We are not going to have breaking news online about this
hearing today. But this is important work. This really brings
``getting into the weeds'' new meaning.
The irony is, everyone is running around this building
giving political statements about how we have to bring down the
spending of the Federal Government. Well, here we have a line
item in the Federal Government that is north of billions and
billions and billions of dollars, and yet it is not going to
garner the attention as some other sexy headline that I am sure
others are covering as we speak over in the main building.
So let me give the formal opening statement that has been
prepared and then we will get to your testimony and questions.
Unfortunately, and Senator Portman asked me to convey to you
that he cannot be here today even though he thinks this is a
terrific subject for this Subcommittee to go at. I think he
would have liked to have been here to discuss even the
complexities of this, but he could not, and so he asked me to
convey that to you and I am happy to do so. He and I are
working well together on this Subcommittee.
Today's hearing focuses on how the government buys food.
Every day, the government provides meals to our soldiers at
home and overseas, veterans, government employees, and to our
children through the National School Lunch Program (NSLP).
Every year, billions of taxpayer dollars are paid to the food
service contractors who supply the food for dining facilities
on military ships, bases, and on the battlefield, as well as at
government buildings, hospitals, and schools.
When food service contractors buy food for the government
they get rebates from the manufacturers, suppliers, and
vendors. In their simplest form, rebates often are based on
volume purchases that contractors make from food manufacturers
and distributors. For example, a contractor may order cases of
cereal from a food manufacturer, for which it will receive a
rebate in the form of a discounted price or a cash payment from
the manufacturer.
In cost reimbursable contracts, the contractor will then
submit invoices for its food purchases to the contracting
agency. The problem is that the invoice price may not include
the rebates received from the manufacturer or the distributor.
So the agency then pays the full amount of the invoice and the
contractor pockets the difference. When contractors buy food
with the taxpayers' money, they should not be able to keep the
change.
Recently, reports of fraud and other abuses on food service
contracts have snowballed. Last July, the New York Attorney
General's Office announced a $20 million settlement with
Sodexo, one of the largest food service management contractors
in the world, regarding allegations that the company failed to
pass along rebates that it received through its contracts with
the New York public schools participating in the National
School Lunch Program.
In September 2010, the Department of Justice (DOJ)
announced a $30 million settlement with U.S. Food Service,
another major contractor, based on allegations that it had
overcharged the government by inflating food prices on
contracts with the Defense Department (DOD) and the Veterans
Administration (VA).
The Department of Justice also has a major case pending
against Public Warehousing Company (PWC), now known as Agility,
based in part on allegations that Public Warehousing Company
submitted false information, manipulated prices, and
overcharged the government for food and related services under
its contract to supply fruit to the military in Iraq.
This June, the Department of Agriculture's (USDA) Inspector
General (IG) announced that it would be conducting its third
audit of food service management contracts in the last decade.
Both of its previous audits, conducted in 2002 and 2005, found
serious problems with companies overcharging schools by
withholding rebates.
The message that these reports and investigations send is
clear. We are not doing enough to make sure that the government
is not getting cheated. With increased scrutiny of rebate
withholding, contractors have turned to new practices in order
to avoid passing rebates on to the government or to pad their
own profits. One such method is to simply call the rebate
another name, such as ``marketing incentives'' or ``vendor
consideration.''
What is more, it seems obvious that the problem is even
more widespread. For example, some companies have said that
their accounting practices prevent them from accounting for the
rebates owed to individual clients. Even if the company is
giving the government the rebates that may be attributable for
the individual contract, there is no way for the government to
recoup the overall rebates that may be attributable to
discounts based on purchases made by an entire Federal agency
or the Federal Government overall.
We are here today to learn from some of the Nation's
experts on this issue on how contractors can manipulate their
prices and invoices. We will discuss barriers to effective
oversight of these contracts, including the complexity of the
contractors' relationships with their vendors and suppliers and
the ambiguities in the Federal regulations relating to rebates.
We will also discuss whether the practices that they have seen
are exceptions or part of a pattern of fraud in these types of
contracts across the Federal Government.
In this time of belt-tightening, we need to be more careful
than ever to ensure that taxpayer dollars are not being
wasted--particularly because every dollar that is lost through
rebate schemes is a dollar that we cannot use to feed our
soldiers and the children who need nutrition.
I thank the witnesses for being here today and I look
forward to their testimony.
Senator McCaskill. And now let me introduce the witnesses
and we will begin the testimony.
It is the custom of this Subcommittee to swear in all
witnesses that appear before us, so before I do your
introductions, if you do not mind, I would ask you to stand.
Do you swear that the testimony you will give before this
Subcommittee will be the truth, the whole truth, and nothing
but the truth, so help you, God?
Ms. Fong. I do.
Mr. Carroll. I do.
Mr. Tiefer. I do.
Senator McCaskill. Thank you all.
Phyllis Fong was sworn in as the Inspector General of the
U.S. Department of Agriculture on December 2, 2002. Prior to
her appointment at USDA, Ms. Fong served as the Inspector
General of the U.S. Small Business Administration (SBA) from
1999 until 2002. Among many other positions of distinction, Ms.
Fong also served as the Assistant General Counsel for the Legal
Services Corporation and an attorney with the U.S. Commission
on Civil Rights. Ms. Fong is also currently serving as Chair of
the Council of Inspectors General on Integrity and Efficiency.
John Carroll is an Assistant Attorney General in the
Criminal Division of the New York's Attorney General, where he
is leading an investigation of billing and marketing practices
among food service companies. He is also the Deputy Chief of
the recently formed Taxpayer Protection Bureau. Mr. Carroll
specializes in civil and criminal investigations involving
allegations of public corruption as well as complex corporate
investigations.
Charles Tiefer is currently a professor at the Baltimore
School of Law, where he teaches government contracting and
legislative process. Professor Tiefer also recently served as a
Commissioner on the Commission for Wartime Contracting in Iraq
and Afghanistan, a commission that is very near and dear to my
heart, and did excellent work.
By the way, I should tell you, Professor Tiefer, that
yesterday, Jim Webb and I hosted here at the Capitol one of the
investigators for the Truman Committee. She was one of the
first women ever hired in Congress to be an investigator for a
congressional Committee and she was in charge of investigating
on the Truman Committee the civilian manpower issues. She was a
1943 graduate of Vassar--and came to work for the Committee for
several years. So Senator Webb and I had a chance to visit with
her. She is anxious to see the report of the Commission, and
asked us to send her one. She lives in Virginia and is a
fascinating woman, and if you are interested, I would be glad
to give you her contact information, because she told some
great stories about the Truman Committee and the work it did
and it was terrific.
Professor Tiefer has also served in both Chambers of
Congress as Legal Counsel and investigated controversies
related to Bosnia as well as the Iran Contra Affair.
We would ask that your testimony be around 5 minutes, but
take as long as you would like, and we will begin with you,
Inspector General Fong.
TESTIMONY OF PHYLLIS K. FONG,\1\ INSPECTOR GENERAL, U.S.
DEPARTMENT OF AGRICULTURE
Ms. Fong. Thank you, Madam Chairman, for the opportunity to
testify today about the work that our office has done to help
improve the Food and Nutrition Service's (FNS) oversight of the
School Lunch and Breakfast Programs and the relationships with
food service management companies (FSMC).
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\1\ The prepared statement of Ms. Fong appears in the appendix on
page 23.
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You have my full statement for the Record, so let me just
highlight the key points.
In fiscal year (FY) 2010, approximately 43 million children
participated in the School Lunch and Breakfast Programs, which
together served an estimated 7.2 billion meals in 14,000 school
districts around the country involving $12.5 billion in Federal
funds. Generally, as you note, the food service management
companies who contract to provide these meals are required to
pass discounts, rebates, and credits for USDA-donated
commodities back to the local school food authorities (SFA),
and those savings can then be used to benefit the students and
the local school meal programs.
Over the last 10 years, we have issued several reports
identifying problems in this program. As you note, in 2002, we
audited eight food service management companies contracting
with 65 local authorities in seven States and we found that
five of those eight companies improperly retained $6 million in
cost savings that should have been passed on to the local food
authorities.
The management companies, who had fixed-rate contracts,
received $5.8 million in USDA-donated food, but they did not
credit this amount to their local food authorities' accounts.
This happened because the FNS requirements on these programs
were not clear and because some companies revised their
contracts to allow themselves to retain savings that should
have gone to the local food authorities.
The remaining $280,000 involved companies with cost
reimbursable contracts, and in those situations, the bid
solicitations would require that rebates and credits be passed
along to the food authorities. In those situations, the
companies that won the bids either modified their contracts or
they ignored the contract requirements.
So in 2005, we did another audit to take a closer look. We
looked at one management company that had cost reimbursable
contracts in 22 States and we found that the company violated
its contracts with 106 food authorities in eight States by not
crediting them with discounts, rebates, and other cost savings
of about $1.3 million.
Together, when you look at the recommendations that our
audits made, we recommended that FNS needed to develop specific
contract terms for State agencies and local authorities to use
when contracting with food service management companies. We
felt that the terms should ensure that SFAs benefit from the
value of the food donated by USDA and also that the SFAs
benefit from any discounts or rebates that companies received.
We also recommended that FNS amend its regulations to require
that these contract terms be included in specific contracts, to
require that State agencies approve contracts before the local
districts sign them, and to require State agencies to have the
local districts enforce the contract provisions. In response to
our recommendations, FNS revised its regulations in 2007, and
in 2009 issued updated guidance to the State agencies and local
authorities.
The issue of food service management companies improperly
retaining savings, however, continues to be a concern, and due
to express concerns that we have received from Congress and
others, we have decided to initiate a new audit to assess the
effectiveness of these corrective actions that FNS has
implemented and to assess the effectiveness of State agency
action. We will also be looking to see if the food service
management companies with cost reimbursable contracts are
passing along the discounts and savings as they should be.
So, in conclusion, we are committed to working with USDA to
strengthen this program. We welcome the opportunity to answer
your questions and appreciate the opportunity to be here today.
Thank you.
Senator McCaskill. Thank you, Ms. Fong. Mr. Carroll.
TESTIMONY OF JOHN F. CARROLL,\1\ ASSISTANT ATTORNEY GENERAL,
OFFICE OF THE ATTORNEY GENERAL OF THE STATE OF NEW YORK
Mr. Carroll. Madam Chairman, please accept the greetings
and the thanks of Attorney General Eric Schneiderman for taking
testimony on this important topic, what are known as in the
industry sometimes as off-invoice rebates. And indeed, Senator
McCaskill, you raised the issue of transparency and the
Attorney General believes that is exactly the problem with this
practice, because it is inherently opaque.
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\1\ The prepared statement of Mr. Carroll appears in the appendix
on page 30.
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I am an Assistant Attorney General and the Deputy Chief of
General Schneiderman's Taxpayer Protection Bureau. Our focus,
like that of this Subcommittee, is to investigate and prosecute
allegations of fraud and waste in government contracting.
The United States and local governments provide millions of
Americans with meals every day, and as a general proposition,
individuals who are receiving meals from the government are
among the most vulnerable. The meals provided by the government
include through the National School Lunch Program, meals in
health care facilities, and meals for soldiers in the field.
The meals are often provided through government contractors
known in this industry as the food service management
companies. Typically, such companies assume complete
operational responsibility for delivering meals in a facility,
whether in a Marine mess hall or a local elementary school. One
task delegated to food service companies which contract with
schools and others to provide this service is the daily task of
ordering food to make meals for children, hospital patients,
and soldiers. Food is bought either directly from food
manufacturers or through distributors. These food vendors pay
food service management companies millions of dollars to buy
food from them. These payments are called rebates or,
tellingly, off-invoice rebates.
The Attorney General's investigation has identified several
problems with the system which, in other contexts, has been
labeled as an unlawful kickback. First, the most obvious
problem. Many food service contracts, as, Senator, you pointed
out, are some version of cost-plus arrangements, but rebates
are most often off-invoice. So, in other words, government
customers who should be getting credit for rebates have no way
to actually account for the numbers because the entire rebating
process takes place behind the scenes, and so they have no way
to police their contracts.
But there is a second, almost more important and definitely
more insidious issue, which is that the rebates create a
conflict of interest, and our investigation has seen the
conflict of interest play out in such a way that very often
food service companies will make food choices driven by the
chase for rebates, which for some companies can amount to
hundreds of millions of dollars in income, rather than issues
of quality or other preferences. So, for example, food service
companies are more likely to enter into rebating agreements
with large agribusiness and may thereby forego entering into
business arrangements with local farmers, which would serve to
thwart the National School Lunch Program's efforts to create
farm-to-school efforts.
So, in conclusion, I am happy to take questions, and once
again, the Attorney General expresses his gratitude for your
interest.
Senator McCaskill. Thank you very much, Mr. Carroll. Mr.
Tiefer.
TESTIMONY OF CHARLES TIEFER,\1\ PROFESSOR OF LAW, UNIVERSITY OF
BALTIMORE SCHOOL OF LAW, AND FORMER COMMISSIONER, COMMISSION ON
WARTIME CONTRACTING IN IRAQ AND AFGHANISTAN
Mr. Tiefer. Senator McCaskill and Subcommittee, thank you
for the opportunity to testify today. I am a Professor of Law,
as you noted, at the University of Baltimore Law School and the
author of a case book on Federal Government contracting. For 3
years, I was Commissioner on the Commission on Wartime
Contracting in Iraq and Afghanistan. Senator McCaskill, you
understated what you did for that Commission. You were one of
the two cosponsors. You created it. You nurtured it. You
inspired it. And, not least, you never let us forget the spirit
of Senator Truman and the Truman Committee during World War II.
That was a very high standard you asked us to measure up to.
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\1\ The prepared statement of Mr. Tiefer appears in the appendix on
page 45.
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For the Defense Department operations in the war zone, the
government purchases the necessary food by its prime vendor
contract managed by the Defense Logistics Agency (DLA). In
recent years, massive criminal and civil fraud charges have
been brought against the food services contractor Public
Warehousing Company, renamed Agility. The scale of these
schemes is breathtaking. Public Warehouse Contracting earned
$8.5 billion in revenue from its Iraq food supply contracts,
and press accounts have discussed that a settlement of the
charges would be on the order between $500 million, $600
million, lawyers said $750 million. Trial has not yet occurred,
so I will use the word ``alleged,'' as you did, for purposes of
the criminal case, but that does not prevent DLA or GAO or this
Subcommittee from taking advantage of what is set forth in the
indictment to make the necessary repairs in the program so that
this does not recur.
In brief, and the pattern is very similar to what my fellow
witnesses described, the contract is supposed to charge the
government a delivered price, which is what the suppliers are
supposed to charge, plus the fee charged by PWC, or the prime
vendor. And we are talking about, even though this is a wartime
supply program, United States food. It is easy to parse the
indictment and see that the bulk of what is being talked about
is food that--meat, chicken, desserts--are produced in the
United States, supplied in the United States, from U.S.
suppliers. And PWC was forbidden to keep rebates or discounts
from suppliers. Its pricing intended that this be passed along
to the U.S. Government. But instead, it used its marketing
muscle to obtain and to keep such discounts, and what made it a
fraud case, a criminal fraud case, was covering this up by
false statements.
I am going to take one of the indictment's examples in a
little detail. In 2005, I am quoting from the indictment--
``U.S. manufacturer S.L. engaged in discussions with defendant
PWC.'' This was about discounts. I might say parenthetically,
the indictment refers to these suppliers with initials, but the
press and blogs have attributed the initials to well-known food
suppliers like Sara Lee.
``Through the discussions between defendant PWC and S.L.
about discounts, PWC insisted that the discount be called an
early payment discount, even though S.L. did not want to use
that term and suggested any discount offer to PWC be called
what it was, a marketing allowance, a rebate. Defendant PWC
insisted the allowance be labeled an early payment discount.
Ultimately, S.L. agreed to use the label.''
I could tick off the other U.S. suppliers mentioned in the
indictment. My statement covers these.
To me, the allegations in the indictment show--just as Mr.
Carroll pointed out--that there were conflicts of interest
here. I would point out that this amounts to corruption, that
the prime contractor who is engaging in kickbacks makes false
reports to the government in words, in numbers, and even
creates an entire false stream of reporting. It corrodes the
whole system of supply for the government and it develops a
whole network of suppliers who may, to some extent, be witting
in this and are willing to comply with the crookedness, to
cooperate in it.
I have some suggestions for what can be done about this. I
think certifications by the prime vendor and declarations of
what they receive would box them in. It would make it extremely
easy to prosecute them or have False Claims Act cases qui tam
brought against them. There is also an extensive study, an
internal study by DLA which is extremely embarrassed that this
happened on its watch. It could be helped to remember the
reforms that it knows it needs to do.
Thank you, Senator.
Senator McCaskill. Thank you very much.
I have a lot of specific questions, and I promise you I
will not ask all of them, but this is an interesting concept,
that someone buys a lot of volume from what essentially is a
broker, a type of middleman, and the middleman service they are
providing is going to go out and locate the various foods that
this program needs. But the volume that is necessary is
dictated by the size of the customer--the fact that it is the
Federal Government, the military or School Lunch Program or
whatever. Are they engaging in getting this kind of extra
padding when they are dealing with potential folks that are not
the government? Is this like the common practice in this
industry, that you get an extra padding on the contract because
you are buying more than one case of Cheerios?
Mr. Carroll. May I?
Senator McCaskill. Sure.
Mr. Carroll. The agreements can run with food distributors,
between food distributors and food service companies, so, for
example, not to--just to use the name, just an example, a Cisco
or U.S. Foods would be examples of distributors, and rebates
can run between the distributors, like Cisco or U.S. Foods, and
the Sodexos of the world. Or it can run between a chicken
wholesaler, a large national chicken wholesaler and the food
service company. And the agreements are not limited to
particular customers, the ones that the Attorney General's
Office has reviewed. They run--so, in other words, the
agreement could be 25 cents rebate on every case of chicken
delivered to Sodexo, and so they----
Senator McCaskill. So it does not matter who is buying it?
Mr. Carroll. Exactly.
Senator McCaskill. And is that the excuse they use?
Mr. Carroll. That is one excuse, that the agreements
actually have to do with volume across all business lines. So,
for example, it could be business for the Senate mess hall or
it could be business for a company, and what the food service
companies will say is, well, we buy for so many different
entities, that is why we are entitled to these discounts. But
the excuse kind of starts to fall apart if you consider that
the buying power of the United States, based on that, the
United States would certainly also be entitled to those
discounts.
Senator McCaskill. Right. So let me start with you, Ms.
Fong. What recommendations are still outstanding on your audits
that were done in 2002 and 2005? I mean, how many findings do
you have with recommendations that they have not yet
implemented?
Ms. Fong. We went back to our audit records in preparation
for this hearing, and currently, FNS has addressed all of our
recommendations and has said to us that they have implemented
all the corrective actions that are necessary. And by redoing
their regulations that they issued in 2007, they believe that
they have addressed the specific recommendations we made. Now,
one of the purposes of our new audit is to actually go out and
see whether their actions have been effective in dealing with
the problems that we had seen earlier in the decade.
Senator McCaskill. They certainly clarified it in 2007.
Ms. Fong. Yes.
Senator McCaskill. I mean, no one can say that is ambiguous
at this point.
Ms. Fong. That is right.
Senator McCaskill. Mr. Carroll, for the investigations that
you have done on the rebate withholding, can you give some
estimate on the amount of dollars we are talking about in terms
of what percentage of the overall contract price could you
attribute to these withheld rebates?
Mr. Carroll. Generally, the rebate amounts that the food
service companies receive on particular products--so it could
be anything from a jar of a particular spice or it could be, as
I said, a case of chicken--run between 5 and 50 percent of the
price that is charged to the customer. So, generally, they fall
on average--in the National School Lunch Program, for example,
it could be around 10 to 15 percent of the price. But there is
a lot of variability because, obviously, you are buying very
different foods to serve in a school program as opposed to a
corporate dining room.
Senator McCaskill. When they are asked for the excuse for
keeping the rebates when they are aware that it is in violation
of the contracts, do any of you have any--can you articulate
what their excuse is, even though it appears fairly clear the
contracts are obviously trying to make sure those rebates are
passed on to the taxpayers, what is the excuse? Is the excuse
the accounting issue?
Mr. Carroll. One issue certainly is the accounting,
especially for a large multinational corporation. But, the
response there is the system is kind of designed to be
complicated. So, in other words, they enter into agreements----
Senator McCaskill. Right.
Mr. Carroll [continuing]. To buy things nationwide and that
involves millions of dollars of payments, and then in order to
get down to how many cases of Cheerios went to this school and
how much rebates is that school entitled to, it is a
complicated exercise, but that is the way the system, in the
view of the investigation, is intentionally designed. In fact,
one target I reviewed some accounting records for entered into
an agreement with its offshore parent in order to further
obscure rebate flow of where the revenues were going.
Senator McCaskill. And that could be this no value added
addition of some company that is there just to be an excuse for
a place to park the rebate?
Mr. Carroll. That is right, and actually, the case that we
settled yesterday involved a relatively smaller regional player
and about $800,000 in rebates, but we settled the claim for
$1.6 million based on the False Claims Act damages. They
entered into what they called marketing agreements, as you
mentioned, Senator, and we reviewed the marketing agreements
and the so-called work product that they supposedly delivered
in exchange for marketing services, and in the view of the
investigation, at least, the so-called marketing services were
illusory.
Senator McCaskill. So they called it marketing services,
created a company and ran it through there in order to add some
legitimacy to parking it.
Mr. Carroll. They created a special department and--
exactly, Senator, to disguise the--because if it was called
``rebates,'' obviously, it would have had to have been
returned. But if it is called something else----
Senator McCaskill. Professor Tiefer, did the Public
Warehousing Company case--are there rebates involved in all of
the charges involving them? Is this all similar to what you
indicated about S.L. and PWC, renaming the rebate an early
payment bonus?
Mr. Tiefer. It comes down to a rebate. There were a variety
of ways that they sort of squeezed a rebate out of the stream
as it went past them. Another way which is more complicated is
that out of their fee, the fee they get from the government,
which is supposed to be all the things they do, including some
processing and packaging and consolidating, they can do it
themselves or they can pay a consolidator. That is supposed to
come out of their fee. But instead, they found ways to throw--
have the suppliers pay for that, add it to what the supplier
was charging, and so the government--which is not supposed to
pay for that, it is supposed to be a reduction in what they are
making--ends up not being a reduction in what they are making.
So it is a roundabout rebate.
Senator McCaskill. Right. Was the contract flawed in the
PWC case? Was there a flaw in the way the contract was drafted?
I mean, if you could go back and look at the way--I mean, in so
many of the wartime contracts, I do not need to tell you, we
said to people, tell us what we need, write the contract, and
tell us what we need to pay. It was all on the side of the
contractor to do way too much of the scoping and the actual
purview of the contract. Were the underlying contracts in the
PWC case actually flawed?
Mr. Tiefer. They certainly need improvement. I will say
this, because when I and a staff team, we talked to DLA, went
to their center in Philadelphia and delved into it, they said,
we are not set up to deal with a fraudulent prime vendor. Our
assumption is we are dealing with people who are honest. And so
there is a limit to how well you can--they were saying, you can
deal with outright fraud, people who make false statements, who
lie about what they are doing.
With that aside, yes, the contract is designed as a fixed-
price contract which has the least visibility for the Federal
Government. But because of the way that the charges get added
together from two different streams, it is not as a practical
matter fixed price.
Senator McCaskill. Right.
Mr. Tiefer. The supplier price can go up and down. Things
can be hidden in it. Things can be subtracted from it. You can
move the back door from it. So it is drafted without protecting
the government.
Senator McCaskill. So it is called a fixed-price contract,
but really, it is anything but.
Mr. Tiefer. I agree. Yes. That is the problem.
Senator McCaskill. I mean, and so the irony is that they
are going to tout this fixed-price contract, oh, it is not cost
plus, it is not cost plus, it is fixed price, but in reality,
it is fixed price just masquerading when it is really cost
plus.
Mr. Tiefer. Yes, and therein lies a big problem in changing
things. As Mr. Carroll said, the industry out there will say
that the industry practice is to do things by fixed price and
we should not impose on them any contract but a fixed price.
They will fight against visibility of their suppliers on behalf
of the U.S. Government.
Senator McCaskill. Yes. Well, we are a big customer. We
ought to have more leverage. You would think that we could
bring these guys to their knees if we were tough negotiators,
but I do not think we have been very tough negotiators,
obviously, in light of the problems that we are hearing about
on all of these contracts.
What kind of contract should we look to? If we were going
to redo--let us just assume we could wipe the slate clean and
we were actually going to exert the power that the Federal
Government has, and we were going to say, this is the way we
are going to contract to buy food. What input can the three of
you give me as to how we would design that model?
Ms. Fong. In the School Lunch Program, as you mentioned,
the complexity of the relationships between the parties is what
really comes into play here. One of the issues that the
Department faces is how can it regulate those kinds of
contracts between a third party and a local school district,
and I think where FNS has ended up, after consultations with
OMB, is that the only way to really reach that is to mandate
contract clauses that USDA can enforce against the local school
districts, not necessarily against the food management company.
And so this is going to be a really interesting review that we
do to see if those contract provisions are going to do the
trick. Basically, those provisions would require the food
service management companies to pass on all rebates and to
specifically and transparently identify the rebates. A very
interesting provision, and I think if it works, it will be a
good model.
Senator McCaskill. Well, and we will be anxious to see,
because, obviously, they are trying.
Ms. Fong. Right.
Senator McCaskill. So if it has worked, then that is the
time that we need to migrate it over to Department of Defense
and to other places in the Federal Government, because
everybody is buying food.
Is this issue that they cannot account for the rebates--
obviously, they are keeping track of this stuff internally,
right? They are making up companies to park it. This sounds
like an unladylike term that Harry Truman would use that has to
do with farm animals and bulls. I have a hard time imagining,
with the complexity of the accounting that has to be embraced
by this kind of contract model, if this is the norm in the food
service industry, that they could not easily pull the thread
and tell us how much the rebates are that they are getting for
these individual contracts within the Federal Government.
Mr. Carroll. I can tell you, Senator, that is absolutely
correct. In fact, a lot of decisions are made--for example,
employees, food service company employees are evaluated on the
basis of manager of school or manager of Marine base, how much
of your purchases are compliant, and compliant means on a list
of products that generate rebates. So the companies have very
sophisticated systems to keep track of and collect rebates from
vendors.
Senator McCaskill. So they are actually encouraging their
folks to utilize those contracts that are most rebate-heavy
internally and they are keeping track of it for purposes of
judging how well their employees are doing at maximizing their
profit?
Mr. Carroll. Absolutely, Senator, and----
Senator McCaskill. Are they giving bonuses based on this?
Do you know?
Mr. Carroll. Well, the personnel evaluations that the
Attorney General's Office reviewed showed that was a component
in the form evaluating----
Senator McCaskill. That makes sense.
Mr. Carroll [continuing]. So among other factors, I think,
that it is fair to say that played a role in whether employees
received bonuses or not. And we also did see e-mail traffic,
for example, where one locale manager--because the way the
business works is you take an employee of the food service
company and they are installed in the school or on the base
and--or in the hospital and they often wear the school's
uniform, the facility's uniform, and there is e-mail traffic
where, for example, one food service company employee was
writing to headquarters saying, ``I found a great source for
locally grown tomatoes,'' and the response came back, ``Don't
do that. That is not where the best rebates are.''
So to pick up on another issue that Professor Tiefer
brought out, which is the game that seems to be being played is
it is changing the name of the revenue flow. So, for example,
in our most recent subpoena, the length of the definition of
the word ``rebate'' is, I think, 250 words, because the name
will change and then, for example, in the National School Lunch
Program, it calls for rebates to be returned, but it does not
necessarily say that contingent compensation has to be
returned.
Senator McCaskill. Or marketing incentives.
Mr. Carroll. Or marketing incentives or whatever the
specific word is, so----
Senator McCaskill. Or you get a bigger bonus at Christmas
if you buy more of this stuff.
Mr. Carroll. Exactly, Senator. So the focus kind of as we
have evolved and started asking smarter questions is, tell us
about the revenue flow that is going in what seems to be the
wrong direction. In other words, if I am buying cases of
chicken, why is the chicken distributor sending me a check? So
whatever you call it, you have to tell me what is that flow,
how much cash is that.
Senator McCaskill. So on accounting, they can keep track of
it if it is going to be their money. They just cannot keep
track of it if it is going to be our money.
Mr. Carroll. That is correct, Senator.
Senator McCaskill. And you brought up a point about the
local tomatoes. One of the things we are struggling with in
this country is how we hold on to independent producers of food
in this country. We obviously have--my State, for example, we
used to have 27,000 feeder pig operations in Missouri. It was
the largest feeder pig operations in the country in my State.
Now, I think we are down to about 7,000 or fewer, and that is
all because they have been bought by or are doing contracts
solely with the big guys.
So as I have gotten to know and understand the issue of
independent producers versus the mega large multinational food
corporations, it is with a sense of urgency that I realize we
have to hold on to the ability of independent food producers to
get a product to market.
Clearly, this system is not working in their favor, because
they cannot afford--an independent producer cannot afford to
pay a quarter on every box of tomatoes, whereas the big guys
that are dealing with huge, huge volume can. So, I mean, the
example you gave in that e-mail is a perfect example of how
local independent farmers are being denied a market in their
local schools because they cannot compete with the Ciscos of
the world in terms of the rebate culture. Is that in any way an
inaccurate summary of the problem?
Mr. Carroll. I think that is absolutely right, Senator. You
could have a situation where a grower has--or there could be a
farm two blocks away from the school that is growing potatoes,
but the food service company is not going to enter into rebate
agreements with every little farmer and every little farmer
does not have the wherewithal to engage in that kind of
transaction.
So, for example, we saw one e-mail string where the local
school manager was saying, we want to buy local apples. It is
good for the business, it is the right thing to do, et cetera,
but we do not have a mechanism to collect rebates. Can we
forego the rebate issue? And then, interestingly, what happens
is the cost of the apples to buy them locally goes up so that
the producers can pay the rebate.
Senator McCaskill. So what they do is they force a price
increase on the local market so that they can take a piece of
it?
Mr. Carroll. I have seen an example, at least one specific
example, of that.
Senator McCaskill. If Kirkwood High School said, there is a
great nursery that has been in Missouri for years and years and
has amazing peaches and amazing apples. If they said, we want
to go out and buy from Eckert's or from these other nurseries,
we want to go buy these, can they not do that? Can they just go
directly and buy local products, or is it because they are tied
to the contracts with these big mega in between companies? Do
you guys know?
Mr. Carroll. They are allowed to purchase locally and there
are rules that permit--this is more a USDA issue than my area
of expertise. They are certainly allowed to buy locally, but as
I said, it is a choice for the food service company whether
they buy locally. And just to give the full story, in fairness,
what the food service companies will say is, well, it is much
easier for us to police food safety issues, uniformity, make
sure we are getting what we think we are paying for if it is
all coming from one giant facility as opposed to if we buy
locally from a thousand local farms, so that----
Senator McCaskill. Well, that may be true, but it seems to
me that would have a lot more credibility if we took the rebate
issue off the table.
Mr. Carroll. I would agree, Senator.
Senator McCaskill. I mean, if, in fact, they were not
getting the extra plus-up by going to the big guys, then we
really would, pardon the expression, have an apples-to-apples
comparison.
Mr. Carroll. Very fair.
Senator McCaskill. Yes. OK. Yes.
Mr. Tiefer. If I can come in on that----
Senator McCaskill. Yes.
Mr. Tiefer. Although theoretically it is possible in the
prime vendor program for the troops in Iraq and Afghanistan to
buy from a particularly good supplier for whatever reason they
think that is a good supplier, the actual situation is that
there are contractors at both ends of the transaction. The
dining facilities in Afghanistan are run by--it used to be KBR.
Senator McCaskill. Right.
Mr. Tiefer. Now it is DynCorps and Fluor.
Senator McCaskill. Right.
Mr. Tiefer. They may very well have a subcontractor who
does the actual running of the dining facility and they just
sort of coordinate at a higher level. So their subcontractor
talks to PWC or the other food service, U.S. Food Service,
Supreme Food Service, or wherever it is. At no point does the
desire of U.S. Government people to do the right thing even
come into the conversation.
Senator McCaskill. Right, because by the time it gets to
where the rubber meets the road, it is two or three degrees
removed.
Mr. Tiefer. Exactly, and it is quite probable that each of
the two corporations at both ends of the transaction are
pursuing their interests rather than anything else.
Senator McCaskill. Right. When you were referring to the
indictment in your testimony and you talked about S.L., and
whether it is Sara Lee or whether it is not. If you think about
the environment in this country as it related to contracting in
Iraq compared to the attitude in this country around
contracting in World War II, I think my predecessor, Senator
Truman, would have an awfully hard time getting his arms around
how big this problem has become. I think in another year,
another time, that company would have said, we refuse to change
the name on this because it appears that maybe you are changing
the name on it in order to profit more at the expense of men
and women who are fighting for our country in a foreign land. I
just do not think that would have been put up with then.
But now, because everyone is so removed from it and it has
gotten so complex, they folded under the pressure from PWC and
did that. I think all of the companies that are allowing
themselves to be manipulated in order to plus-up these
contractors should be ashamed of themselves, particularly in
the context of Iraq and Afghanistan. I think it is really
inexcusable.
Why do you think, Professor Tiefer, that we see so often
that the government keeps doing business with these
contractors? I mean, it is my understanding, correct me if I am
wrong, that the government continued to do business with PWC as
they had a lot of evidence in front of them about this fraud.
Is that correct, or am I incorrect in those facts?
Mr. Tiefer. You are, unfortunately, quite correct. PWC not
only had the giant Iraq food service product, it also was one
of KBR's major subcontractors on some stuff for the logistics
contract. So, yes, we had multiple flows of renewing contracts
going out to them.
Senator McCaskill. And are we still doing business with
them?
Mr. Tiefer. That is a good question.
Senator McCaskill. We will find out.
Mr. Tiefer. Let me say, when the indictment came down, this
was one of the ones where at least--this has not happened in
all cases--they were suspended and debarred from obtaining new
contracts. So there certainly was a period of time they could
not obtain new contracts, and I cannot tell you whether that
period came to an end of not.
Senator McCaskill. OK. And that is extraordinary, because I
cannot tell you how many times in this Subcommittee we have
talked about the failure to suspend and debar.
We have talked about the fact that we believe the guidance
is pretty clear now, Ms. Fong, about FNS. I am aware there is
at least one legal case that is casting doubt on FNS's ability
to regulate contracts through the School Lunch Program. Should
we be concerned now that the regulations that are currently
written are not enough to hold these contractors in check as
this case is working its way through the court?
Ms. Fong. Right. If you are referring to the decision from
Pennsylvania in 2009, we took a look at that and the rebates
that were the subject of that case were rebates that had been
paid between 1992 and 2002, which was under the prior
regulatory framework----
Senator McCaskill. I see.
Ms. Fong [continuing]. Before FNS had the authority in
place. Our sense is that with the current regulatory framework,
there should be a way to go after these kinds of situations.
But we are very happy to work with your staff to flesh out that
issue a little more.
Senator McCaskill. OK.
Professor Tiefer, in your view, do the requirements
outlined in Part 31 of the Federal Acquisition Regulations
(FAR) apply to contracts executed under Part 12?
Mr. Tiefer. They do. I looked into this especially for this
hearing. These are commercial contracts. That is why we asked
whether Part 31 about payments applies to the Part, I think it
is 12 that is for commercial, and there was a holding by the
GAO. Extraordinarily, it was by PWC itself that protested to
the GAO that said, we are a commercial company. This is a
commercial contract. Requirements should not apply to us. That
is getting in the way of the commercial way that rebates freely
flow around. And the GAO stomped on that. It is part of a
continuing stream of rulings that GAO gives about when--what
concessions you have to make to commercial contracts and when
you keep government safeguards, and this is one of the
government safeguards that GAO wanted to keep.
Someone mentioned to me, though, that the GAO ruling is not
the end, you can go to the Court of Federal Claims, and that
issue is pending in the Court of Federal Claims, so there is
still some ambiguity.
Senator McCaskill. Since there have been protests with GAO
and we think those have been resolved appropriately, what, if
anything, are things specifically that you all can bring to our
attention today that you think we need to further investigate
in this very murky area of rebates or marketing incentives, or
extra juice for the or middleman, whatever you want to call it?
What other investigations do you think we can be doing from
this Subcommittee, or what legislative fixes could we do that
would clarify contracting law as it relates to the ability of
the Federal Government to enjoy the discounts they get because
of the amount of volume they are purchasing?
Mr. Tiefer. If I can put one answer to that, I completely
agree with Inspector General Fong earlier who said that
identifying rebates, clearer clauses in the contracts to
identify all manner of rebates, is necessary, and I thought
that was a very healthy suggestion.
I would add that there need to be audit clauses, that we
need to get the auditors in on this situation. Let me say, if
someone says to me, why, that is ridiculous, of course, the
auditor is already in on this, it is a fixed-price contract.
Senator McCaskill. Right.
Mr. Tiefer. There are very limited capacities for auditors
to go in. If you try to put auditors in now, it is quite
possible that the industry will challenge this and will say,
look, the audit clause speaks of cost reimbursement contracts,
time and materials contracts, but it does not say fixed-price
contracts, so the audit clause does not apply. And that applies
in spades to the problem of looking at the suppliers, which is
often necessary. Unless you have a flow-down clause in the main
contract that says that the auditors can look at the suppliers,
a Federal auditor shows up, says, who are you, which government
are you with----
Senator McCaskill. Right.
Mr. Tiefer [continuing]. We never heard of you. The United
States? Are you somewhere around here?
Senator McCaskill. Right. So that would be something that
we could actually require. And, by the way, I know this is
possible to do because in Medicare Part D, they actually
specified that the government was not allowed to negotiate for
volume discounts. If I can remember back to legislative
construction in law school, which I am trying to live every
day--I think that would mean that there is an assumption that
the government can always negotiate for volume discounts unless
they are prohibited from doing so by law, like they are in
Medicare D. So it seems to me that this is something that we
need to underline and put an exclamation point on.
Anything else from anyone about what we can be doing?
Auditing clauses and identifying the rebates in the contracts.
Are there other things that you think we need to be doing?
Mr. Carroll. Well, if there was a mechanism, and I have no
expertise whatsoever in legislative drafting, but if there was
a mechanism to move the rebates up so that they appear on
invoices.
Senator McCaskill. Transparency.
Mr. Carroll. Transparency----
Senator McCaskill. On the invoice.
Mr. Carroll. Right. And then it is hard to see how anybody
could have any objection to regulating this, if the question
is, we just want to know what is going on and then we are
negotiating on fair territory.
And one other thing I wanted to pick up on what Professor
Tiefer raised, and I think you also raised, Senator, is this
issue of why are companies paying this. In some conversations
with vendors, the sense is if we do not pay them, we do not get
access to the markets, and food service companies like the
large ones have enormous markets. So we may not like paying
them, but we are going to get shut out if we do not. So I would
think that you would have some constituency there. It would not
be a completely one-sided battle. I think that there are a lot
of entities who would like to eliminate this practice.
Senator McCaskill. So the vendors would probably be on our
side?
Mr. Carroll. I suspect.
Senator McCaskill. Yes. I bet you that is correct. And I
know the local independent producers would be.
Mr. Carroll. Absolutely, Senator.
Senator McCaskill. Right.
Ms. Fong. One issue that we would like to put on the table,
as you mentioned, is suspension and debarment as a remedy. We
have been trying to give some thought to that, as to whether
suspension or debarment would be appropriate or available with
respect to food service management companies. And the sense
that we have is that the Federal Acquisition Regulation, would
not allow a procurement debarment for an FSMC because the FSMC
is not a contractor with the Federal Government and so that is
a big issue.
Then the other question is, is there any way--because the
food----
Senator McCaskill. But we could fix that legislatively. We
could say, if the flow of dollars are Federal dollars, then any
agents that are hired to run programs that are funded through
Federal dollars must be subject to Federal laws of suspension
and debarment for failure to perform under the contract. I
would think we could do that.
Ms. Fong. I think that would be worth exploring.
Senator McCaskill. We do an awful lot with putting
handcuffs on everyone about what they can do and not do if it
is Federal money. I cannot imagine that we could not do that.
It seems like, to me, that is much more logical than a lot of
the handcuffs we have out there right now. So, OK, that is a
good suggestion.
Anything else? Inspector General Fong. Mr. Carroll.
Professor Tiefer.
Mr. Tiefer. You talked about what investigations could be
done. Now, you have a lot on your plate, Senator. You look at a
whole wide array, and I do not know if I want to bog you down
on this one, but I would think a survey of some of the
contractors here, whether it is the suppliers or the main
vendors--Mr. Carroll noted the wide range of discounts
involved, the percentages involved, and it would be interesting
to get some sense. They have to answer under oath if they are
surveyed.
Senator McCaskill. That is exactly right.
Mr. Tiefer. Yes.
Senator McCaskill. I will tell you that the Subcommittee
intends to submit document requests at the close of this
hearing to agencies, to Federal agencies and companies with
food service management contracts. We are going to try to get
an accounting of the retention of rebates by the contractors
and an understanding of the policies that are in place at the
agencies that contract for food service management. We want to
address through these document requests the potential issues in
domestic contracting, such as that seen in the New York Schools
contracts and the problems discussed by DLA. The investigation
should also hopefully shed some light on service contracts in
contingency operations, as demonstrated by the Agility case and
the support for further oversight and transparency.
I cannot go into details, but I got second-and third-hand
that there was actually a conversation that was had in
Afghanistan not too long ago about a potential contract and
someone mentioned that might not be a good idea because of the
quote-unquote team, and my name was used. But my name should
not be used because I think they were referring to the team of
people who work on this Subcommittee who feel very strongly
about really shedding the light on contracting abuses in the
Federal Government and the amount of money that is being wasted
as a result of those abuses.
And I want to take this hearing to congratulate the field
of government auditors on the arrests that were made yesterday,
the Inspector Generals that worked on that case involving the
Army Corps of Engineers, an Alaska Native Corporation, and the
blatant and brazen fraud that was going on between government
contracting officials and this company involving massive
kickbacks and massive over-billings to the Army Corps of
Engineers. That case came about because of people like you, and
I know what you would do if you had the opportunity right now.
You would point to your staff and the great work they do,
because there are thousands of government auditors out there
that deserve the respect and, frankly, the funding of this
government because they are really doing the heavy lifting in
this regard. So congratulations to all the government auditors
involved in that case and the many others that do not get the
attention they deserve.
We will continue down this road. If I could ask that you
all continue to be cooperative with the staff on this
investigation, we are going to keep going down this road
because I think there is real money here. I think there are
significant dollars that we can save in the purchase of food by
the Federal Government if we pull this thread all the way to
its logical conclusion and clean this area up once and for all
and provide that transparency. It will allow everyone to figure
out what they are paying for and whether they are getting the
best deal.
And please convey to your boss, Mr. Carroll, that we
appreciated his cooperation with allowing you to come here
today. I have taken that train back and forth and it is easier
sometimes than the shuttle. I do not know which you took, but I
am glad you came here today to help us with this, and we will
continue to call on you for the expertise you have developed in
the cases you have worked on.
I thank all of you for what you have provided here today
and we will continue to be in contact with you as we continue
down this path to try to clean this up once and for all. Thank
you all very much for today.
[Whereupon, at 3:03 p.m., the Subcommittee was adjourned.]
A P P E N D I X
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