    [House Hearing, 114 Congress]
    [From the U.S. Government Publishing Office]

    .
                     CONTRACTING AND THE INDUSTRIAL BASE
    =======================================================================

                                    HEARING

                                   BEFORE THE

                          COMMITTEE ON SMALL BUSINESS
                                 UNITED STATES
                            HOUSE OF REPRESENTATIVES

                        ONE HUNDRED FOURTEENTH CONGRESS

                                 FIRST SESSION

                                   __________

                                  HEARING HELD
                               FEBRUARY 12, 2015

                                   __________

    [GRAPHIC NOT AVAILABLE IN TIFF FORMAT]

                Small Business Committee Document Number 114-001
                  Available via the GPO Website: www.fdsys.gov

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                                 U.S. GOVERNMENT PUBLISHING OFFICE
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                       HOUSE COMMITTEE ON SMALL BUSINESS

                          STEVE CHABOT, Ohio, Chairman
                                STEVE KING, Iowa
                          BLAINE LUETKEMEYER, Missouri
                            RICHARD HANNA, New York
                             TIM HUELSKAMP, Kansas
                            TOM RICE, South Carolina
                             CHRIS GIBSON, New York
                              DAVE BRAT, Virginia
                 AUMUA AMATA COLEMAN RADEWAGEN, American Samoa
                            STEVE KNIGHT, California
                            CARLOS CURBELO, Florida
                              MIKE BOST, Illinois
                             CRESENT HARDY, Nevada
                   NYDIA VELAAZQUEZ, New York, Ranking Member
                            YVETTE CLARKE, New York
                              JUDY CHU, California
                            JANICE HAHN, California
                         DONALD PAYNE, JR., New Jersey
                              GRACE MENG, New York
                           BRENDA LAWRENCE, Michigan
                           ALMA ADAMS, North Carolina
                          SETH MOULTON, Massachusetts

                       Kevin Fitzpatrick, Staff Director
                Stephen Dennis, Deputy Staff Director for Policy
                Jan Oliver, Deputy Staff Director for Operation
                          Barry Pineles, Chief Counsel
                      Michael Day, Minority Staff Director
                                C O N T E N T S

                               OPENING STATEMENTS

                                                                       Page
    Hon. Steve Chabot................................................     1
    Hon. Nydia Velaazquez............................................     2

                                   WITNESSES

    Mr. Randall D. (Randy) Gibson, President, Whitesell-Green, Inc.,
      Pensacola, FL, testifying on behalf of the Associated General
      Contractors of America.........................................     3
    Mr. James P. Hoffman, PE, President, Summer Consultants Inc.,
      McLean, VA, testifying on behalf of the American Council of
      Engineering Companies..........................................     5
    Mr. John McNerney, General Counsel, Mechanical Contractors
      Association of America, Rockville, MD..........................     6
    Mr. Andrew Hunter, Director, Defense-Idustrial Group and Senior
      Fellow, Center for Strategic and International Studies,
      Washington, DC.................................................     8

                                    APPENDIX

    Prepared Statements:
        Mr. Randall D. (Randy) Gibson, President, Whitesell-Green,
          Inc., Pensacola, FL, testifying on behalf of the Associated
          General Contractors of America.............................    22
        Mr. James P. Hoffman, PE, President, Summer Consultants Inc.,
          McLean, VA, testifying on behalf of the American Council of
          Engineering Companies......................................    42
        Mr. John McNerney, General Counsel, Mechanical Contractors
          Association of America, Rockville, MD......................    50
        Mr. Andrew Hunter, Director, Defense-Industrial Group and
          Senior Fellow, Center for Strategic and International
          Studies, Washington, DC....................................    60
    Questions for the Record:
        None.
    Answers for the Record:
        None.
    Additional Material for the Record:
        The Design-Build Institute of America (DBIA).................    69
        The National Association of Surety Bond Producers (NASBP) and
          The Surety & Fidelity Association of America (SFAA)........    74

                      CONTRACTING AND THE INDUSTRIAL BASE

                                  ----------

                          THURSDAY, FEBRUARY 12, 2015

                      House of Representatives,
                   Committee on Small Business,
                                                        Washington, DC.
        The Committee met, pursuant to call, at 10:30 a.m., in Room
    2360, Rayburn House Office Building. Hon. Steve Chabot
    [chairman of the Committee] presiding.
        Present: Representatives Chabot, Gibson, Radewagen,
    Velaazquez, Chu, Hahn, Meng, Adams and Lawrence.
        Chairman CHABOT. Good morning. While I am beginning my 19th
    year as a member of the Small Business Committee, this is my
    first hearing as chairman. In that capacity, I look forward to
    working with my friend and colleague, the ranking member, Ms.
    Velaazquez, and all of my colleagues on both sides of the aisle
    in an effort to improve the plight of American small
    businesses. I am particularly pleased to see that we will begin
    that endeavor today by discussing a subject that has much
    promise for small businesses and taxpayers alike, federal
    contracting reform.
        As you know, the government has a goal of awarding at least
    23 percent of federal prime contract dollars to small
    businesses, and in Fiscal Year 2013, we met that goal for the
    first time in many years. Early indications are that we met the
    goal again last year. However, it is not enough to simply meet
    the goal; we have to focus on why Congress created those goals
    in the first place.
        The goals exist as a tool. They are intended to make sure
    we have a broad spectrum of small businesses working with the
    government across industries. Having a healthy small business
    industrial base means the taxpayers benefit from increased
    competition, innovation, and job creation. It also means that
    we can securely support programs crucial to our national
    defense. The percentage of dollars awarded to small businesses
    is a good measure of success, but it is not the only measure.
    Indeed, it appears that over the last four years, while the
    percentage of dollars being awarded to small businesses was
    increasing, the number of contract actions with small
    businesses fell by almost 60 percent. At the Department of
    Defense, the number fell by almost 70 percent. The size of the
    average individual small business contract action increased by
    230 percent during that same period, and by nearly 290 percent
    at DoD. These statistics are all alarming in their own way, but
    one of the more clear cut and disturbing figures is that there
    are over 100,000 fewer small businesses registered to do
    business with the Federal Government than there were in 2012.
    These data points suggest we have a problem with our small
    business industrial base.
        Today's witnesses are going to address specific
    recommendations to improve the competitive viability of our
    small business contractors. This is only the first of a series
    of Full Committee and Subcommittee hearings we will be having
    on this topic. As chairman, I expect that the Committee will
    actively pursue ways to increase opportunities for small
    businesses to access capital and contracts, while removing
    barriers to small business success. And I am quite confident
    that our Subcommittee chair, Mr. Hanna, and his Subcommittee on
    Contracting and Workforce, will be thoroughly exploring this
    issue in the very near future. And I look forward to working
    with each of you and want to welcome our witnesses here this
    morning.
        I now would yield to the ranking member for the purpose of
    making an opening statement.
        Ms. VELAAZQUEZ. Thank you, Mr. Chairman.
        For several decades now, the federal government has looked
    to the private sector to provide services and supplies for its
    day-to-day operations. As such, a vibrant industrial base has
    become essential to the U.S. economy and our national security.
    It comes as no surprise to those in this room that small
    businesses are at the heart of the supply chain. With a strong
    presence in a variety of different industries, from
    construction to manufacturing, small businesses continue to
    play a vital role in providing our government with goods and
    services. In order for this sector to continue its resurgence,
    we need to ensure that small businesses are able to compete
    both globally and here in America.
        Here at home this means ensuring that small firms can gain
    access to the nearly $500 billion federal procurement
    marketplace. Numerous policies and protections have been put in
    place to ensure their continued participation in this arena.
    This includes goals, set-aside programs, and the assignment of
    federal personnel to work on behalf of small contractors. Many
    of these initiatives have evolved over the years to reflect the
    changing needs of small firms. In many regards, these efforts
    have paid off as small businesses last year won nearly $100
    billion in awards. However, it appears that we have stalled,
    and in many ways the goal is becoming a ceiling rather than a
    floor.
        And with regard to set-aside programs, we continue to see
    over and over again non-small businesses gaining access to
    small business awards, whether it is HUBZone, service disabled
    veterans, or 8A awards, we need stronger protections to keep
    bad actors out of the federal marketplace or trying to gain
    access to federal contracts that were designed for small
    businesses in the first place.
        Another trend is occurring that may also impact small
    contractors. Data shows that the average contract size is
    increasing. On first take, this appears to be promising as
    larger contracts might be more profitable for small companies.
    However, it might suggest that more contracts are being
    consolidated, resulting in fewer opportunities for small
    businesses. I am particularly interested in the witnesses'
    perspective on this during today's hearing.
        What is important for this committee to keep in mind is
    that these developments are part of a bigger picture, which is
    that the federal procurement marketplace is always evolving.
    Whether it is sequestration, reductions in federal procurement
    staff, or the rise of multiple award contracts, there will
    always be new issues for small businesses to overcome. And
    against this backdrop, we must ensure small businesses are not
    left behind and that procurement laws evolve with this changing
    landscape.
        During today's hearing, I look forward to learning about
    the challenges facing small contractors and possible solutions.
    Doing so is not only essential for small firms and our nation's
    industrial base, but the economy overall. Small firms bring new
    ideas to the table which in turn generate new jobs and even new
    industries. Taken together, this is a key part of what has made
    the U.S. the leader in today's economy.
        I thank all the witnesses for being here today, and I yield
    back the balance of my time. Thank you, Mr. Chairman.
        Chairman CHABOT. Thank you. The gentlelady yields back. And
    if Committee members have opening statements prepared, I would
    ask that they submit them for the record.
        And I would like to take just a moment to explain the time
    rules that we operate under here, which is the same that the
    other Committees do. It is the five-minute rule. You will have
    five minutes to testify. We will have five minutes, each of us,
    to ask questions. We even have a lighting system set up for
    that. The green light will come up. You can talk for four
    minutes. The yellow light comes on to let you know you have one
    minute to wrap up. When the red light comes on, we would ask
    that you try to terminate your testimony as close to that as
    possible. So we give you a little leeway, but not much. I
    appreciate your cooperation.
        And I will now introduce our first witness, who is Randall
    Gibson--or Randy Gibson, our son's name; not Gibson, but
    Randy--who is president of Whitesell-Green, Inc., a general
    contractor in Pensacola, Florida. He is also the chairman of
    the Associated General Contractors (AGC), Naval Facilities
    Engineering Command Committee, and a member of the United
    States Army Corps of Engineers Committee. He is testifying
    today on behalf of AGC.
        We thank you for being here, and you are recognized for
    five minutes.

     STATEMENTS OF RANDALL D. GIBSON, PRESIDENT, WHITESELL-GREEN,
     INC.; JAMES P. HOFFMAN, PRESIDENT, SUMMER CONSULTANTS,, INC.;
        JOHN MCNERNEY, GENERAL COUNSEL, MECHANICAL CONTRACTORS
       ASSOCIATION OF AMERICA; ANDREW HUNTER, DIRECTOR, DEFENSE-
      INDUSTRIAL GROUP AND SENIOR FELLOW CENTER FOR STRATEGIC AND
                         INTERMNATIONAL STUDIES

                     STATEMENT OF RANDALL D. GIBSON

        Mr. GIBSON. Chairman Chabot, Ranking Member Velaazquez, and
    members of the Committee, thank you for inviting the Associated
    General Contractors of America to testify on reforms to the
    Federal Government's contracting laws important to our
    industry.
        My name is Randy Gibson. I am president of Whitesell-Green,
    Incorporated, a small business based in Pensacola, Florida,
    providing general contracting and design-build service to
    Department of Defense and other federal agency clients
    throughout the Southeastern region of the United States.
        Since our founding in 1970, my company has constructed over
    400 heavy commercial projects, resulting in nearly one billion
    dollars in completed contracts.
        While my written testimony covers all the topics for
    today's hearing, I will use the time allotted today to address
    the need for Congress to (1) prohibit all federal agencies from
    procuring construction services through reverse auctions; and
    (2) encourage sensitive consideration of past performance
    records in joint venture and teaming context.
        AGC strongly supports full and open competition for
    construction contracts; however, reverse auctions for
    constructions services have the effect of turning away
    qualified and experienced contractors, especially small
    business firms like mine, for a host of reasons. Procurement of
    construction services is different than for manufactured goods
    like pens and paper. Construction services are complex, most
    often requiring the participation of numerous trade
    subcontractors and vendors in lower-tier arrangements with the
    general contractor. They are project-specific and inherently
    variable. And they require a large degree of professional
    expertise.
        In a reverse auction, nonprice factors of consequence to
    the owner, such as quality of relationship, past performance,
    scheduling, long-term maintenance, and unique needs are
    deemphasized by the process. In a reverse auction, a bidder has
    no incentive to offer its best price. Winning bids may simply
    be an established increment below the second lowest bid, not
    the lowest responsible and responsive price. In a reverse
    auction, discipline is difficult to maintain. General
    contractors can underbid the contract simply to win the award,
    putting the government at significant risk to receive lower
    quality construction and even contractor default. This also
    exposes subcontractors to risk for nonpayment.
        It is my belief that AGC's position on reverse auctions is
    shared by other important stakeholders to the procurement
    process. The U.S. Army Corps of Engineers, the White House
    Office of Federal Procurement Policy, and even the largest
    reverse auction vendor to the Federal Government, FedBid, have
    all publicly stated that reverse auctions for construction are
    not appropriate. Yet, agencies like the Department of Veterans
    Affairs, the Department of the Interior, and the General
    Services Administration continue to conduct them. Considering
    this inconsistency, AGC urges members of this Committee and
    Congress to enact a law that prohibits reverse auction
    procurement for construction services government-wide.
        Turning to the joint venture and teaming issue, AGC and its
    members are increasingly finding that federal agencies will
    disqualify small businesses from competition when they seek to
    partner with another business for the first time. In an
    environment where agencies are bundling contracts worth upwards
    of $100 million, and specifically setting them aside for small
    business, it is often beyond the capacity of a small business
    alone to bond and perform such large-dollar projects.
    Consequently, small businesses, like my firm, often seek to
    partner with other small or nonsmall businesses to win such
    awards.
        Some federal agencies are not allowing small businesses and
    their partners to submit the relevant past experience of each
    individual company to prove qualification for the contract.
    Rather, agencies demand that the small business and partner
    submit only past experience that they have performed together,
    or otherwise be disqualified from consideration. This
    limitation often prevents the governments from receiving the
    benefit of project-specific experiences and resources which the
    first-time collaboration of these teams may offer.
        AGC strongly supports a sensible legislative solution to
    ensure that federal agencies reasonably consider the individual
    past performances of construction contractors seeking to joint
    venture or team, even if they are teaming for the first time.
        Thank you again for the opportunity to testify. I look
    forward to answering your questions to the best of my
    abilities.
        Chairman CHABOT. Thank you very much. And thank you for
    staying within the time constraints.
        Our next witness is James Hoffman, who is president of
    Summer Consultants, Inc., in McLean, Virginia. Prior to
    starting with Summer over 22 years ago, Mr. Hoffman served as a
    platoon leader and company executive officer in the 317th
    Engineer Battalion in the United States Army. He is testifying
    on behalf of the American Council of Engineering Companies.
        We thank you for being here today. We thank you for your
    service, and you are recognized for five minutes.

                     STATEMENT OF JAMES P. HOFFMAN

        Mr. HOFFMAN. Chairman Chabot, Ranking Member Velaazquez,
    and members of the Committee, I appreciate the opportunity to
    testify before you today about the issues surrounding
    contracting and the industrial base.
        My name is James Hoffman, and I am the president of Summer
    Consultants, a consulting mechanical, electrical, and plumbing
    engineering firm located in McLean, Virginia. Summer
    Consultants is a small business with 30 employees. Our practice
    focuses on the federal market for the past 50 years. My firm is
    an active member of the American Council of Engineering
    Companies, the voice of America's engineering community. ACEC
    oversees over 5,000 member firms, represents hundreds of
    thousands of engineers and other specialists throughout the
    country, are engaging a wide range of engineering works that
    propel the nation's economy, and enhance and safeguard
    America's quality of life. Almost 85 percent of these firms are
    small businesses.
        Design build is a type of construction where engineers team
    with industry professionals. There are two forms of design
    build--two-step and one-step. Two-step requires the team submit
    qualification packages to the contracting officer in the first
    round. The contracting officer reviews them and notifies the
    teams if they are selected for the second round. At this point,
    the design build team develops expensive and detailed plans for
    the contractor to bid, generally without any reimbursement.
    Industry best practice has three to five finalists in the
    second round. In the recent years, there have been more than 10
    finalists at some competitions as current law allows the
    contracting officer to increase the number of finalists without
    limitation. This causes problems for both the industry and for
    the government. My firm's marketing risk is inversely
    correlated to the number of finalists, and the contracting
    officer must review all the proposals and give feedback to each
    team member that does not win the project, which is time-
    consuming. This issue has driven many, including small
    businesses, out of the federal market.
        One-step design build creates an even more precarious
    environment. One-step allows the owner to solicit complete
    proposals from the construction market without a qualifications
    review. This forces out small businesses as they cannot spend
    dollars on projects where there are too many competitors, many
    of which may not have the qualifications for the project. It is
    an inefficient process for the Federal Government as it asks
    the contracting officer to review multitudes of proposals. This
    Committee has been a strong supporter of this issue, and we ask
    the Committee to continue to improve the design build market by
    supporting the reintroduction of H.R. 2750.
        The second issue, the Court of Federal Claims ruling on the
    nonmanufacturer rule, poses a challenge for the construction
    industry, as it is a service industry that typically did not
    have to address this rule in the past. The rule exists to
    ensure that a contract for goods is restricted to small
    businesses, rather than act as a pass-through for large
    entities. The course interpretation would require that any firm
    who is a prime contractor be responsible for their
    subcontractors' use of small business products, and
    potentially, the many different tiers of subcontractors as is
    undefined at this time.
        The burden on this rule is staggering as I, as a business
    owner, would have to take the most conservative view to make
    sure that I am complying with the law. We have concerns that
    due to the unknown nature of this rule, that we can be
    penalized by an overbroad court ruling. ACEC asks the Committee
    to work with SBA on language to make sure that construction
    services and products continue to be excluded from the rule.
        I urge Congress to reintroduce H.R. 2750 and enact it into
    law. I also encourage Congress to work with the SBA to limit
    the scope of the nonmanufacturing rule on service industries.
    These bills can help my firm and other engineering firms to
    serve our clients' needs and thrive.
        Thank you for the opportunity to participate in today's
    hearing, and I would be happy to respond to any questions from
    the Committee members.
        Chairman CHABOT. Thank you very much for your testimony.
        I would now like to introduce our next witness, John
    McNerney, who is general counsel of the Mechanical Contractors
    Association of America, the MCAA. The MCAA represents about
    2,500 firms involved in heating, air conditioning,
    refrigeration, plumbing, piping, and mechanical service. We
    thank you for your testimony here that you will be giving this
    morning, and you are recognized for five minutes.

                       STATEMENT OF JOHN MCNERNEY

        Mr. MCNERNEY. Thank you, Mr. Chabot. Good morning, Ms.
    Velaazquez.
        On behalf of the 2,500 members of MCAA, thank you very much
    for the opportunity to be here. I am general counsel, and I
    have been involved in the work of this Committee for several
    years now, as have our members. We testified here several times
    on the old 3 percent withholding tax on Federal Government
    contracts, and we commend your work on that. You were
    persistent, and we hope it does not come back again. That was a
    big threat to cash flow and prompt payment for all our members.
        We also would commend you for your recent activity having a
    naming rule for small businesses in prime contract, small
    business contracting plans, and allowing those firms some
    assurance that they will be selected or have recourse to the
    contracting officer if they are not.
        Having said that, we also admire your persistence on the
    reverse auction rule. The Federal Government lags the private
    sector in recognizing just how bad that practice is. So we hope
    this time we can pursue that until we get it where it should
    be.
        The Corps of Engineers Pilot Study on Reverse Auction came
    in more than 10 years ago. They studied nine projects, and they
    came out with a conclusion in about a 95-page report that said
    it was totally unacceptable for low bid awards. But since then
    it has been fitful by getting this Congress to do something
    about it. Our statement on it is attached to my written
    statement. In summary, it says simply this. There is a strong
    discipline in the sealed bid, low bid process that protects the
    project owner's best interest in well-considered judgments by
    its bidders, and all that discipline is lost in the publicly
    disclosed price auction with hasty and frenzied judgments
    imperiling careful offers and awards.
        You know, back in 2004, when this started, a lot of private
    sector industries took this up. Most of them have given up the
    project, and those who have not have been fired by customers,
    fired by the contractors as their customers. And we think that
    the persistence of some government agencies to do this is
    impairing competition.
        So in all, I think there are three problems with the
    reverse auction. Number one, it shows that some bad ideas, like
    the 3 percent withholding tax, for example, have a habit of
    recurring. Projects that are mischaracterized as commodity
    purchases then are subject to the lack of discipline of the
    sealed low bid, and when construction projects are
    misclassified as commodity purchases, the government and the
    contractor are deprived of protections and benefits of the many
    standards for construction contract clauses that serve to
    allocate risk fairly. The unforeseen conditions cause, the
    equitable change clause, the prompt payment clause, and some of
    the warranty clauses, too.
        So in summary on that point, we commend the Committee for
    pursuing this and trying to finally implement the Corps'
    categorical assessment that this is a bad practice. Nothing has
    changed since then that would mitigate that conclusion, so we
    look forward to your reintroduction of that bill.
        We would also suggest when you do that, that you consider
    expanding it Part 15, Negotiated Procurement. And Part 14,
    Sealed Bid, is where we are looking at it now, but we
    understand that many agencies are going to a species of
    negotiated procurement, low priced technically acceptable where
    once the team is evaluated it becomes a low bid process. So we
    need to legislate those kind of controls into that process. Our
    members are having anecdotal evidence that there are selection
    abuses in LPT awards as well.
        On the individual surety reform, we are fully in support of
    the industry consensus. There is no harm and only benefit to
    closing the individual surety loophole where there can be
    elusory assets and fraud and bad practice there. Your reform
    preserves the possibility of individual surety but protects
    against the abuses, so we think that can only increase
    competitiveness in that market.
        And on the nonmanufacturing rule, I talked to my members
    and they said they cannot buy a tiller from a small business
    company or an air handling unit or mechanical equipment. It is
    entirely inapt for our industry.
        So with that, sir, I will stop and look forward to your
    questions.
        Chairman CHABOT. Thank you very much. I appreciate your
    testimony.
        I would like to yield to the ranking member.
        Ms. VELAAZQUEZ. I guess that you started out on the wrong
    track today.
        Mr. Chairman, it is my pleasure to introduce Mr. Andrew
    Hunter. Mr. Hunter is the director of the Defense-Industrial
    Initiatives Group and a senior fellow for the International
    Security Program at the Center for Strategic and International
    Studies here in Washington, D.C. He focuses on issues affecting
    the industrial base, including sequestration, acquisition
    policy, and industrial policy. Prior to joining CSIS, Mr.
    Hunter served as a senior executive at the Department of
    Defense, including as chief of staff to Ashton B. Carter and
    Frank Kendall, while each was serving as under-secretary of
    defense for Acquisition, Technology, and Logistics.
        Welcome, Mr. Hunter.

                       STATEMENT OF ANDREW HUNTER

        Mr. HUNTER. Well, thank you, Chairman Chabot, and Ranking
    Member Velaazquez. Thank you for the opportunity to testify to
    you today about contracting and the industrial base.
        I am Andrew Hunter from CSIS, and as mentioned, prior to
    being at CSIS, I worked at the Department of Defense under two
    undersecretaries of defense for Acquisition. And prior to that,
    I spent 17 years working in various capacities in the House of
    Representatives. So this is a little bit of a homecoming, and a
    happy one.
        A major focus of my work at CSIS involves understanding the
    evolving partnership between the Federal Government and the
    industrial base. This partnership is critical to the successful
    execution of the more than $400 billion in federal contracting
    that occurs annually. I have a particular focus on how this
    partnership is evolving between industry and the Department of
    Defense; however, CSIS performs in-depth analysis on data from
    all federal agencies, and I will try to keep that hat on today.
        The industrial base is important because without it the
    Federal Government cannot function. The health of the
    industrial base, therefore, is of critical importance to the
    nation as a whole. While federal contracting is only a small
    portion of the overall economy, it is nonetheless very
    important to certain sectors of the economy and the industrial
    base, especially those that focus on government-intensive
    areas, such as defense, transportation, and healthcare, not
    least of great importance to many small businesses.
        Contract obligations represent the overwhelming majority of
    the federal spending that is received by industry, and
    examining the contracting data is essential to understanding
    what is happening in the industrial base.
        I will briefly summarize some of the chief findings of the
    analysis that CSIS has done on this data and try to provide
    some context for the discussion today and hopefully for the
    Committee's work in this Congress.
        Our first central finding is that sequestration is
    currently the dominant force in federal contracting. With
    repercussions that have been particularly severe in defense
    contracting, but also across the board. We are in the midst of
    a significant reduction in federal contract obligations that
    are affecting every sector of the contracting world in the
    industrial base.
        Within that overarching story, secondly, there is an
    important dynamic going on specific to research and
    development. Federal contracting for research and development
    performed by industry is particularly challenged under
    sequestration, potentially impacting the historical role that
    small businesses have played in technology innovation that
    Ranking Member Velaazquez referred to in her opening statement.
    A great deal of the cutting-edge innovation has its source in
    small business. They are frequently incentivized to pursue
    innovative technologies that larger businesses do not have the
    same incentive to pursue. And that has been important to the
    nation over many years.
        R&D contract obligations are declining much more rapidly
    than overall contract obligations, and we have not reached the
    bottom yet, even though we are likely approaching the bottom
    for contract obligations overall.
        Third, small business contracting is highly sensitive to
    changes in the overall federal contracting environment. Small
    businesses are likely to be significantly affected therefore by
    return to sequestration levels, spending levels in 2016.
    Contract obligations with small businesses plunged in the first
    year of sequestration, 2013, then happily, but somewhat
    unexpectedly, recovered very well in 2014. I believe the
    reality for small business in truth is somewhere between the
    crisis picture that the 2013 data presents and the relatively
    healthy picture that the 2014 data presents. But I suspect that
    a return to full sequestration would send us, again, in a
    sharply downward directly.
        And then lastly, the composition of small businesses
    participating in federal contracting has been significantly
    reshaped since 2000, which is when a lot of the federal data
    started to become widely publicly available contracting data.
    And much of this has been the result of policies established in
    the Small Business Act. And I mention this to point out that
    the future direction chosen by this Committee will shape the
    future of small business contracting over the next 10 to 15
    years, so it is very important. The work of this Committee is
    very important.
        And lastly, I just want to emphasize that the continuing,
    in some cases increasing complexity of the federal contracting
    process referenced by many of my colleagues here, remains the
    most significant barrier to entry for firms of all sizes in the
    industrial base, particularly small business. And small
    businesses are challenged to absorb the overhead required to
    successfully navigate through this vast complexity. And I would
    say when you are making these decisions, I would suggest that
    you tend to err as much as possible on the side of reducing
    complexity in all of these approaches.
        So thank you, and I stand ready to address your questions.
        Chairman CHABOT. Thank you, Mr. Hunter. We thank all the
    panel members for their excellent testimony here this morning.
    And I will begin with myself with five minutes of questioning.
        How can we get more small business construction companies
    to compete for federal work as either prime contractors of
    subcontractors? And Mr. Gibson, if you do not mind, I will
    start with you. And anybody else that would like to weigh in is
    welcome to do so.
        Mr. GIBSON. Taking from my own experience, sir, as a small
    business, I would say the way to invite more firms to get
    interested and involved in federal contracting would be to
    hopefully take some of the regulations away that sometimes
    deter firms from entering the marketplace. And also to enhance
    the teaming and partnering ideas that we have been talking
    about in my testimony today. Lots of times a firm needs a
    mentor or somebody who has been in the federal construction
    process. Allowing them to team, show their own qualifications,
    share the qualifications of their partner, get involved, learn
    the ropes, that would be an opportunity for them to ease their
    way into the marketplace.
        Chairman CHABOT. Thank you very much.
        Mr. Hoffman, did you want to weigh in on that?
        Mr. McNerney?
        Mr. MCNERNEY. My members would agree with that ability to
    partner and team more. My very small members, of which I have
    many, do that and they would like to do more of it. And the
    idea that all the team members would be evaluated is a good
    idea. Any more discerning selection criteria is highly favored
    by my members because they prosper when the selection criteria
    is high.
        Chairman CHABOT. Okay. Thank you.
        Mr. Hunter, did you want to weigh in?
        Mr. HUNTER. I would just say I think this gets a little bit
    to the design build discussion that happened earlier; that the
    more you can make it easier for companies to get in the front
    door and participate, the better. I think having more companies
    engaged in the front end of the process is a good thing, and it
    is true that the bid and proposal costs can be one of the major
    barriers to entry. I think the trick a little bit in that is
    for the government having to evaluate based on a list of
    qualifications makes it a little bit hard on the contracting
    officer to withstand bid protests. And bid protests are
    something that we are seeing has a very pervasive influence
    throughout the contracting process. It is driving many more of
    the decisions that get made than I think it was ever really
    intended to be driving. And so I think sort of that larger
    story is playing out in the design bid and the construction
    context.
        Chairman CHABOT. Okay. Thank you.
        Let us see, Mr. Hoffman, I think I will start off with you
    on this one. Some would argue that by only having five teams
    submit full bids on a design build project we are limiting
    competition. Could you explain why the two-step process is
    actually pro-competition? Arguably pro-competition?
        Mr. HOFFMAN. Yes, sir.
        First of all, the first phase of competition is open to
    everyone. So everyone is able to participate. And then with
    respect to the second step, what we are going to find is that
    the most experienced architect, engineers, and construction
    contractors are going to step out if there are more than five
    construction contractors. So we are going to have less
    qualified people participating in federal projects because the
    opportunity to win that project with significant investments is
    dramatically diminished once you go beyond the three to five
    recommended in industry practices.
        Chairman CHABOT. Thank you.
        And then I will have each of you just address this very
    briefly, if you would. If you could just tell us legislatively
    what you would like to see us do; if there were one or two
    things that we could do that would really make a difference?
    Maybe I will start with Mr. Hunter this time and go in the
    opposite direction.
        Mr. Hunter, if you want to suggest one or two things.
        Mr. HUNTER. Yeah. I am going to make a suggestion that may
    be slightly hard to implement. But as I mentioned, I think
    trying, wherever you can, to reduce complexity in the system is
    the way to go.
        Chairman CHABOT. I would go with Mr. Gibson's reducing the
    regulations basically.
        Mr. HUNTER. Yes. And of course, you have to be careful.
    Many of these regulations have a history. They exist for a
    reason, but I think there are frequently less complex ways to
    implement the statute and regulations and to get the same job
    done.
        Chairman CHABOT. Okay. Mr. McNerney?
        Mr. MCNERNEY. Mr. Hunter's comment about the roadblocks and
    the complications from bid protests is a good one. And I do not
    know how you would legislate that, but our members prefer a
    more robust evaluation, a past performance evaluation on
    completed contracts, more robust than exists now. If you had
    that and more widespread use of the federal awarded past
    performance information system, I think would help bolster
    selection criteria, exclusions, if you will. Again, I think
    that our members on the main would like to see the selection
    process be more discerning, and I think that would increase
    competition. Some of my members say they will not compete in
    the federal market because of not so careful selection
    procedures.
        Chairman CHABOT. In order to enforce my five-minute rules
    against myself, I am going to cut it off at that point. And I
    will either talk with you briefly or in a second round or we
    will get back to it. But I now recognize the ranking member for
    five minutes.
        Ms. VELAAZQUEZ. Thank you.
        Mr. Hunter, in evaluating the awards to small businesses
    over the last few years, there seems to be a trend in which the
    dollar value of small business contracts has increased. What
    effect does this concentrated dollar value have on the small
    businesses' industrial base?
        Mr. HUNTER. It is a very interesting point. As someone who
    spends a lot of time analyzing contract data, it would be great
    if we could dig deeper into that and understand. Is it because
    the locus of where the awards are happening within the space of
    federal contracting? In other words, is it because it is more
    construction happening and less in the world of supplies?
    Because that can affect contract size. Construction projects
    are going to be bigger than most commodity purchases.
        But having not carefully analyzed it at this point, my
    suspicion is that it is not that; that it is, in fact, that the
    average awards are growing bigger across the board, because our
    data shows that small businesses are generally succeeding in
    the areas where they have always succeeded in the contracting
    process. And I do not know if that is being driven by the way
    the government is putting out solicitations and proposals. That
    would generally probably be the first place to look.
        Ms. VELAAZQUEZ. Do you think that bundling has a lot to do
    with that?
        Mr. HUNTER. It certainly could. It could also be that some
    of the smaller purchases which may have historically been done
    with small businesses, if they are now being done with a
    purchase card at Walmart, you know, that may be driving some of
    that. Smaller business and directions away from small
    businesses. And I think if it is an issue of interest, having
    someone take a deeper look at that, those trends, would be
    good.
        Ms. VELAAZQUEZ. Thank you. Thank you.
        Mr. McNerney, during its pilot program of reverse auction,
    the Corps found that the process might move too quickly for
    competitors to actually reassess their costs or the way they
    will actually do the work. There have even been reports in
    which the buyer had to step in to prevent a supplier from
    meeting a price that would harm the company. Do you believe
    that contractors are actually able to perform the contract at
    the price they beat or are some of them putting the viability
    of their company at risk?
        Mr. MCNERNEY. All of that, Ms. Velaazquez. I read the
    report on the subway down here and the Corps of Engineers says
    all of that very empathically. And I talked to some of my
    members yesterday who were involved in--the pharmaceutical
    industry was a big adopter of this back in 2002-2003. I will
    not name the company, but I asked him, I said, `` Did you
    continue to bid that work as either prime or sub?'' And he
    said, `` No, I fired that customer.'' Because when the hasty
    judgments--the first Corps of Engineer Pilot Study ended up in
    a bid protest because the prime contractor who won said he did
    not mean to push the button the last time, ironically. So that
    tells you, what is that, an error in judgment or a clerical
    error?
        Ms. VELAAZQUEZ. Do you believe then that some of the same
    concerns that we see in construction reverse auctions will
    exist in other industries?
        Mr. MCNERNEY. I think it is very likely. You know, the
    Corps of Engineers report said that for commodities it can be
    done well and it can help you find the lowest price. But the
    hearing you held last year with the VA did not prove that out.
        Ms. VELAAZQUEZ. Right. Okay, thank you.
        Mr. Hunter, the contribution of small businesses to R&D has
    long been recognized as critical to our economy and national
    security as these firms have developed some of the most
    innovative technology. You noted in some areas of your
    testimony the decline in R&D contracting at the Department of
    Defense, indicating that this is a worrisome trend that is
    incompatible with achieving national objectives. Can you
    explain this statement and what this trend means for the
    industrial base?
        Mr. HUNTER. Yes. What we found is that the magnitude of the
    reduction in contract obligations for R&D is much greater than
    what you see overall. I think that is a result of the fact that
    for many--for the Department of Defense for certain, and for
    many federal agencies, there is a lot of rigidities within
    their budget that make it very hard to cut in other areas. And
    obviously, in the case of the Department of Defense, there is a
    strong desire to avoid cuts to things like military
    compensation. And so then the cuts have to be taken elsewhere.
    And R&D is inherently something that can be rescheduled and
    retasked fairly quickly because you are inventing things and
    you cannot invent on a schedule. The contracts are all designed
    to reflect, to be rewritable or adjustable as work proceeds.
    And that is good in a R&D context, but it also means it is very
    easy to, when the budget cut comes, to take money out of that
    contract.
        Ms. VELAAZQUEZ. But let me ask you a last point. Given the
    fact that when it comes to R&D spending, the agency has so much
    flexibility. How can we reverse that trend?
        Mr. HUNTER. I think it is making it clear that this remains
    a priority. And I mentioned in my testimony that the goals and
    objectives that have been set in statute have actually reshaped
    the way that contracting is being performed. And so I think
    continuing to emphasize the importance of research and
    development and innovation is a key thing.
        Ms. VELAAZQUEZ. Thank you.
        Chairman CHABOT. The gentlelady's time has expired.
        The gentleman from New York, Mr. Hanna, is recognized for
    five minutes.
        Mr. HANNA. Thank you, Chairman.
        Boy, there is a lot to talk about. The 3 percent rule is
    gone. Relax. I cannot imagine it coming back.
        In the last Congress, we worked on some of the subjects you
    mentioned, Mr. Gibson, in particular, reverse auctioning is, I
    mean, you all stated it one way or another, but it is a race to
    the bottom. I think we worked with the Department of Defense. I
    think with the chairman's permission, we can--I would like to
    continue on that path because I could not agree with you more.
    When all you have to do is click a button to be lower than the
    guy a moment before you, it does add, as you said, a degree of
    irrationality, and everyone wants to work. So everyone always
    thinks they can do a little bit better than they thought. So I
    get that.
        And in terms of the overall conversation though about
    bidding in general, one of the problems with the whole process
    is, and one of the reasons for bid protests is the very
    subjective nature of everything you do, which feeds back to the
    conversation over reverse auctioning and why it is such a bad
    thing. But how do you protect the interest of the public and at
    the same time limit the number of bidders? How do you take out
    those elements that cause people to protest bid? Because it is
    easy to do and it is easy to find a reason to do that.
        I personally was in that business for many years, so I have
    seen a lot of that. I guess it is hard to have everything.
    Like, with Mr. Hunter, how do you have a vibrant industrial
    base, have sequester, and have an efficient R&D, an effective
    R&D, and still have the right to cut back on the cost of doing
    business? I mean, you cannot just fund an industrial base
    because you always want them to be there. You cannot just pay
    people to manufacture things because someday you may need them,
    although you could argue that you might. I wonder how you
    balance all that.
        Mr. Hoffman, maybe you would like to say something about
    it. And anyone else.
        Mr. HOFFMAN. With respect to competition, the issue for us
    would be the design build piece. So everyone has the
    opportunity through sources--and small businesses can
    participate in that and it can be set aside. Irregardless of
    whether it is small business or it is unrestricted, small
    businesses can participate as part of larger teams, and
    everyone would benefit and the standard to follow the best
    practices of three to five bidders so that we can go ahead and
    make sure the best qualified teams are pursuing things.
        Mr. HANNA. So really what you are saying is you need a
    better way to qualify bidders, limit the number of bidders, and
    frankly, let the government have a more thoughtful and
    deliberate process for deciding not just how many, but how and
    what.
        I am interested though, Mr. Hunter, what do you think of--
    how do you maintain all that?
        Mr. HUNTER. Well, I would say, you know, I think this issue
    of how does the government basically arbitrate amongst
    proposals, and if it is a list of qualifications, it may be a
    case that everyone has great qualifications and it is very
    difficult to discern the difference. Or it may be the case that
    it defaults to whoever has the longest history of past
    performance, which again, is not going to necessarily get new
    entrants into the process. I know the Department of Defense and
    in the R&D context, a lot of times they use an approach that is
    referred to as a `` white paper.'' And so you are asking folks
    to give you at a relatively low cost, something that is fairly
    short, but some description of what the approach that they
    would take to the problem would be. And that at least can
    provide a middle ground. I am not sure how well it works in the
    construction contracts because how far can you go into talking
    about a construction project before you are into some
    significant expense? In other contexts that can provide I think
    a way for the government to distinguish and to kind of call out
    the best folks to do the more expensive proposal.
        And I would say on your question about innovation, I think
    prototyping can be something that is a good middle ground, if
    you will, that allows for you to do work on innovative
    technologies without going to the expense of, again, designing
    an entire system that the government probably does not have the
    funding to actually purchase.
        Mr. HANNA. Thank you.
        Chairman CHABOT. The gentleman's time has expired.
        The gentlelady from California, Ms. Chu, is recognized for
    five minutes.
        Ms. CHU. Well, this question is for anybody on the panel,
    and it has to do with reverse auctions. You have all been
    pretty vociferous in being against reverse actions for the
    construction industry, and you have said that it does not
    guarantee the lowest price, may encourage imprudent bidding,
    does not allow for a thorough evaluation of value, and does not
    ensure that the successful bidder is responsive and responsible
    and may, in fact, go against federal procurement laws. And in
    fact, the Army Corps of Engineers study found that it did not
    even offer marginal savings over a sealed bid process. I find
    that very interesting because the reason for reverse auctions
    in the first place was to get to the lowest price. So I would
    like your comments on any of these factors that have come out
    because of the reverse auctions.
        Mr. GIBSON. Yes, ma'am. As a construction contractor, I can
    tell you that you might have what you think is the lowest price
    at time of award but it is the price you pay at the outcome
    that determines the real price of the job. If you have losses,
    if you have under proposals in there, they are going to come to
    life during the performance of that contract, and they are
    going to cause the government buyer a lot of problems. So I
    think it is putting up a smokescreen as to what real cost is
    when you invite that type of imprudent bidding.
        And I will give you one example. As a construction
    contractor, most typical jobs I bid involve about 30 to 50
    crafts, other companies coming to me to offer their services, 5
    to 10 offers in each craft. There are several hundred people
    offering prices on bid day. Sixty percent of those prices come
    in within the last two hours prior to the bid deadline. So in
    the reverse auction process, how does the contractor have the
    opportunity to go back to those people and say, `` Can you do
    better?'' He is making a guess, and those guesses end up
    costing the government in the long run.
        Mr. HOFFMAN. I might add that with respect to engineering
    services, reverse auctions, they do not look at lifecycle cost
    analyses and total cost of ownership. So the lowest cost is not
    necessarily the best cost. So if we look at construction in
    facilities, that cost is a small fraction of the total
    ownership costs once you go ahead and look at ongoing operation
    and maintenance. And I would urge the Committee to consider
    that, and I think you can only focus on first cost reverse
    auctions. I have no idea how you are able to understand what
    the total cost is of ownership when you do that.
        Mr. MCNERNEY. I would just emphasize what Mr. Gibson said.
    Reverse auction is the antitheses of a best value selection
    process, which I think is also the answer to Mr. Hanna's
    question. You know, the government has gone to design build
    best value to get away from the problems that existed in
    contract claims and dispute and defense of contract
    administration back when all projects were low bid, before 1994
    Competition and Contracting Act.
        So I think Mr. Hanna, the answer to your question is, too,
    you have got to, you know, you have got to allow the CO to have
    governed discretion. He has the contracting warrant. He has to
    make discretionary judgments, and the bid protest agencies have
    to back him up.
        Ms. CHU. If I may change topics, Mr. Gibson, the SBA has
    two surety bond guarantee programs that guarantee 70 to 90
    percent of the bonds up to $6.5 million in value to assist
    small businesses. However, many construction companies are not
    using the program and the individual sureties have filled the
    void. Why do you believe construction companies are not
    utilizing the program, and what are the steps that could make
    this program more attractive? Like, for instance, if they were
    guaranteed by 100 percent or if the total guaranteed value is
    increased from $6.5 million?
        Mr. GIBSON. Ma'am, I have to tell you that I am not a
    surety expert. I have had the relationship with my same surety
    for 40 years, one surety. So I know very little about their
    operations. I trust the solid company that I have been working
    with for 40 years, and I would prefer to defer to somebody else
    on the panel that might be able to talk about those
    distinctions.
        Ms. CHU. Okay. Anybody else on the panel?
        Mr. HUNTER. Well, I would just say about surety bonds, I
    think it is reflective of another issue in federal contracting,
    which is access to capital. And I think historically, when the
    Federal Government was sort of a bigger part--federal
    procurement was a bigger part of the overall economy, there was
    always just an assumption that it was a gold standard; that the
    private sector would always be willing to front the capital to
    make a federal contract work, and what we are finding is that
    that is not as true anymore. The margins to be made on
    government business are not as attractive in many cases as what
    companies can find in the tech sphere. So it is just not as
    attractive to a lot of companies to engage in this business,
    and it takes a little more effort on the part of the government
    to get companies involved.
        Chairman CHABOT. The gentlelady's time is expired.
        The gentleman from New York, Mr. Gibson, is recognized for
    five minutes.
        Mr. GIBSON. Well, thanks, Mr. Chairman.
        Just to start off, to both chairman and ranking member, I
    am excited to join the Committee. Looking forward to our work
    together. Small business, a huge part of upstate New York. And
    so to get this opportunity to provide a voice for our small
    business owners is a real privilege.
        Good session here. I am learning quite a bit and I
    appreciate the comments. Definitely taking notes here with
    regard to reverse auction, the bidding process, and how we are
    proceeding with protests, insights that you are providing for
    improvements.
        I am going to make a couple of observations of things that
    I have heard in my time moving around the 19th Congressional
    District and somewhat informed by the 29 years I had in uniform
    before I came to Congress. I would be interested in your
    commentary or perhaps policy recommendations that may be able
    to address some of these things. I do not think there will be
    anything surprising about what I am going to mention here. Just
    given your expertise, I would love to hear if you have some
    thoughts on how we could change law or insights on regulation
    to do better.
        The first is, I had a company in Kingston that I thought
    was really doing excellent work with regard to protection for
    our troops. Body armor and protection of both people and
    equipment. But they were having a hard time getting the
    attention of the DoD. And so sort of the first phenomenon, is
    there something about the processes, RFP and whatnot, that
    would cast a net a little wider and allow for small businesses
    who are doing really creative stuff, to make sure that they
    knew what the government was looking for, and for the
    government to get a better appreciation or even situational
    awareness on what small businesses are doing; number one.
        And number two is somewhat related. I have, and I do not
    think this is an epiphinal comment, but one of the value added
    of small businesses is that you really see agility. You see
    responsiveness and you see boldness in terms of pulling things
    together. Then the issue becomes one of scale. You go ahead and
    you really hit it and you hit it well, but then how do you
    compete? What I saw in my time in the military is it almost
    seemed like the DoD would rather safe side it and go to a
    bigger company, even if they might have been impressed with
    some of the ideas of a smaller company, because they did not
    want to take on the risk. And so there was this issue of scale.
    I do not know, maybe there is a finer point on design build on
    this score, but I would be interested in anyone from the panel
    commenting on those two general points. And then if you have
    any policy recommendations, I would love to hear them.
        Mr. GIBSON. I can just speak from personal experience on
    your scale issue. As a small business contractor, I have
    observed an inclination over the past several years for the
    purchasing agencies of the government to prefer the larger
    contractors. I actually had it said to me by agency
    representatives that they think they are buying down risk when
    they hire the larger contractors. And we have had to be
    creative to work--as a small business, to work around that. We
    have had to go outside of our marketplace, our custom
    marketplace to find work.
        Mr. HOFFMAN. Actually, with respect to scale, I think if we
    talk to the various agencies, it is interesting. Many times the
    contracting officers and some of the project managers appear to
    be willing to embrace the utilization of small businesses, but
    then they also need to sell it to their customers, and their
    customers can be more risk adverse. Certainly, we have seen a
    good many sources sought and a good many opportunities for
    small businesses, at least in our sector, to participate, and
    we appreciate that.
        With respect to policy changes, again, in our testimony, we
    would suggest the reintroduction of H.R. 2750 and the
    clarification of the nonmanufacturing rule.
        Mr. HUNTER. I think your example actually about troop
    protection is a really great case. Because that is one where
    the government tends to want to take a low-risk approach for
    very understandable reasons that you can certainly appreciate.
    And it is expensive to test some of the items and to prove out
    that they meet the specs that the government is looking for
    which are fairly stringent.
        Interestingly enough, there is a program at the Department
    of Defense called the Foreign Comparative Test Program that
    exists for a similar reason, to allow the department to test
    out equipment from overseas that may be something that we do
    not have here, and to pay for the testing just so that it can
    show what its capabilities are. And I think having some small
    amount of budget to sort of demonstrate, allow small companies
    to demonstrate what their products can do so that the buyer
    then does not have the fear that a smaller firm may not have
    designed something that is going to stand up over time or meet
    the spec. And the Army has done good work on this with field
    testing, essentially, of articles in the electronics realm that
    has really expanded the envelope of people able to participate.
    I think in troop protection that could be a very valuable
    example.
        Chairman CHABOT. The gentleman's time has expired. Thank
    you, gentleman.
        We will go to a second round at this time, and I will
    recognize myself for five minutes. I am not sure if I am going
    to take the whole five minutes.
        But my last question in the previous round, I had asked
    what legislatively would you like us to do, and we heard from
    Mr. Hunter and Mr. McNerney, so I would like to give Mr.
    Hoffman and Gibson an opportunity to suggest what maybe
    legislatively you would like to see us take up. I will prompt
    you by giving a couple of bills that I know that we are
    considering now, and I think you may be somewhat familiar with.
    One is Chairman Hanna's bill relative to surety bonds. And
    another is H.R. 2750, which is a design build bill; H.R. 2751,
    which has to do with reverse auctions. These were in the last
    Congress introduced, and I am sure we will be working on them
    this Congress as well. Another was the nonmanufacturing rule
    and also teaming and joint venture legislation. So those are
    some of the things. So you can either comment on those if you
    would like to or other things if you would like to bring to our
    attention, what you would actually like to see us do. And maybe
    I will begin with either one of you.
        Mr. Hoffman, do you want to go?
        Mr. HOFFMAN. Thank you.
        Actually, each one of those rules are in our written
    testimony, and we would encourage the Committee to pursue and
    pass those proposed reforms. And that would be what we would be
    looking for, sir.
        Chairman CHABOT. Okay. You cannot be much more specific
    than that. Thank you.
        Mr. Gibson?
        Mr. GIBSON. Absolutely the same. We support all of those,
    and have added that to our testimony as well today.
        Chairman CHABOT. Okay. Thank you very much.
        I think I am going to stop there. I got the answer I
    wanted, so thank you.
        I will now yield to the gentlelady from New York, the
    ranking member, Ms. Velaazquez.
        Ms. VELAAZQUEZ. Yes, I would like to go back to Mr. Hunter.
    We are now reviewing the budget for Fiscal Year 2016. In your
    testimony you mentioned that your data shows small business
    contracting numbers increased in the last fiscal year, despite
    the cuts imposed by sequestration. Can you give us an
    explanation as to why that happened? What can you tell us
    regarding the spending levels that are proposed for Fiscal Year
    2016 and whether they represent a significant risk for small
    business growth?
        Mr. HUNTER. I will do my best. The same answer would be to
    say we need more data. What we have seen in several areas, and
    I will try to maybe highlight a little and not be cryptic. For
    example, we saw big differences between the military services
    and the way that their contracts were playing out. So the
    Army's contract obligations have sort of fallen off a cliff.
    The Navy showed surprisingly little variation in their contract
    obligations. And then the Air Force was somewhere in the middle
    and it was very hard to understand how you could have three
    such different outcomes when they are all facing relatively the
    same level of cuts. The 2014 data has now come in. We find
    that, in fact, it is the Navy whose contract obligations have
    gone down now quite a bit in 2014, much more so than 2013, and
    the other services not as much. And I think what is happening
    is that things are shifting around. So there is a semi-
    artificial barrier there which is the end of the fiscal year--
    one fiscal year, the start of another. And to some extent the
    appropriations in terms of when they go on contract can be
    fungible across that boundary. And so I think there is a lot of
    shifting that is going on. And so I think work from 2013 got
    shifted essentially into 2014, partly probably due to the
    uncertainty when sequestration kind of came down in the middle
    of the fiscal year, and partly because of strategies that
    different agencies adopted. And so I suspect that if you were
    to sort of take the two years and average them out, that might
    be--and assume that in reality sort of that, there was more of
    a steady state trend line there and that those two numbers are
    extremes and the reality is somewhere in the middle, I suspect
    that is the case.
        So taking you then to 2016, this question of does it go
    back down to the full sequester levels and another drop? Or
    does it now start to go in a positive direction in terms of the
    total federal obligations? It is going to, I think, again, kind
    of, you know, it will be--in some ways it surprised agencies
    whichever outcome occurs because they have budgeted now for
    what the president's level is, which is higher, and if it ends
    up going back to sequestration, there is going to be that
    surprise again. And that is why I think it will be a sharp drop
    if that happens.
        Ms. VELAAZQUEZ. Thank you, Mr. Chairman.
        Chairman CHABOT. The gentlelady yields back.
        The gentleman from New York, Mr. Hanna, is recognized.
        Mr. HANNA. Thank you.
        Surety bonding. You know there was a bill in the last
    Congress that almost made it. It died but for one person in the
    Senate. You are familiar with that. Basically, it meant that
    bonding had to be backed by real assets. It is not that
    complicated and it is not that much to ask. We know that it has
    not always been that way. I would just like to give you a
    chance to talk about that, Mr. McNerney and Mr. Gibson. You are
    both in that racket, so.
        Mr. MCNERNEY. There are those notorious cases that you have
    all heard from the NASBP and the surety and fidelity, the
    individual surety who pledged coal waste as the security for a
    bond. If there were a claim made on that, my contractor would
    have been out of luck. He would have been on the hook for all
    his payroll and everything else when the prime failed. So I
    just think it is a very good government abuse. It is just a
    transparently bad loophole in the law. The contracting officers
    do not deal with it properly. It is more prevalent than you
    would think, I am afraid. What I hear from NASBP, it is just--I
    do not think you lose the virtues of independent----
        Mr. HANNA. Bonding has always been based on a zero loss
    ratio. As soon as you factor in any loss at all, you are
    degrading the contractor and you are degrading the process.
        Mr. MCNERNEY. Right.
        Mr. HANNA. You would agree with that, Mr. Gibson?
        Mr. GIBSON. Yes. And I would say that we are here talking
    about small businesses. That loophole is very dangerous for
    small businesses who are thinking about getting into the
    Federal Marketplace. You do not want to step into the Federal
    Marketplace without a solid surety behind you, and you cannot
    get a solid surety unless you are solid yourself financially.
    So this Committee should help protect small businesses by
    closing that loophole.
        Mr. HANNA. Mr. Hunter, implicit in your statement--and I
    will just admit, just for myself, that sequestration is pretty
    ham-fisted and not nearly as discriminate as any thoughtful
    person would want it to be. But knowing that and knowing the
    other issues with the debt and the deficit and the way people
    feel about all that, and I agree with that, how do you maintain
    research and development and how do you maintain these
    companies without just throwing money at them to make sure they
    are in business when you need them? Because that is implicit in
    your statement, and yet, that is not logical necessarily to
    everyone, and certainly not to me.
        You have got two minutes. I mean, I would kind of like to
    know about that dynamic because we have, in my district,
    companies that are deeply invested in doing work for the
    government and find themselves through sequestration in trouble
    right in the middle of things that they are doing that
    everybody thinks are important. It is an interesting problem.
        Mr. HUNTER. It is. And I think the government needs to be
    very discriminating about how it approaches and how it invests
    its R&D dollars. And so I think that is kind of the answer in
    both directions to your question I would argue.
        Mr. HANNA. But you would agree; you just cannot throw money
    at the problem.
        Mr. HUNTER. You cannot throw money at the problem, and we
    do not need to be investing government dollars where the
    private sector is going to invest its own dollars. And
    generally, they are probably going to, I mean, history shows
    they are going to be successful in that in enough cases to make
    it not worth the government investment. So I think the
    government then needs to focus. When R&D budgets are declining
    and the government has to focus very hard, there is a tendency
    to say, well, we are going to invest in an area because we
    invested in it last year. We thought it was good then, it must
    still be good now. At a time like this, you really need to
    revisit those assumptions and say maybe the world has moved on.
    And in some cases it has. And in communications technology, the
    advancements on the commercial side are so rapid, it is highly
    unlikely the government investment is ever going to----
        Mr. HANNA. So do you mind, can I speculate and say that
    sequestration is not all bad because it has made some people
    more thoughtful about how they do things and how they manage
    their total budgets?
        Mr. HUNTER. I would say the government should be thoughtful
    without sequestration.
        Mr. HANNA. But maybe it helped?
        Mr. HUNTER. And part of the problem with sequestration is
    it does not allow a lot of thought. So we end up cutting
    everything, even the things that are critical and necessary,
    and yes, we may have cut some of the things that are less
    critical and necessary, but we cut them exactly 10 percent, not
    100 percent as maybe we should have. And so I think it is those
    rigidities and that mechanism.
        Mr. HANNA. Except in the last, they did allow for
    discretion in terms of that. That was the original way it went.
    But that changed, so.
        Mr. HUNTER. Well, but there are still rigidities within the
    budget process that tend to drive the cuts to certain areas,
    R&D in particular, more so than places where we maybe should be
    cutting.
        Mr. HANNA. Thank you. My time is expired. Thank you,
    Chairman.
        Chairman CHABOT. Thank you very much. The gentleman's time
    has expired.
        We want to thank all of the witnesses for their
    participation here this morning. It has been very helpful I
    think to the Committee. The testimony we heard I believe shows
    that there are changes this Committee can make to improve the
    competitive viability of small construction and A&E contractors
    and improve the health of our industrial base. We look forward
    to working closely I think on this issue and all issues.
        And I want to ask unanimous consent that members have five
    legislative days to submit statements and supporting materials
    for the record.
        Without objection, so ordered. And if there is no further
    business to come before the Committee, we are adjourned.
        Thank you.
        [Whereupon, at 11:45 a.m., the Committee was adjourned.]
                                A P P E N D I X

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                                    A C E C

                   AMERICAN COUNCIL OF ENGINEERING COMPANIES

        Introduction

        Chairman Chabot, Ranking Member Velaazquez, and members of
    the committee,

        The American Council of Engineering Companies (ACEC)
    appreciates the opportunity to testify before you today about
    the issues surrounding Contracting and the Industrial Base and
    specifically about the unique considerations within engineering
    services and construction more broadly. ACEC believes that
    small businesses can flourish in the federal market, but there
    must be continued oversight by this and other committees to
    reduce barriers to market entry. There must be a focus on
    improving the marketplace for design and construction services
    by eliminating wasteful spending by both the federal government
    and contract participants during the procurement process. ACEC
    will address issues that are present in federal design-build
    procurement, the potential issues with the implementation of a
    new court decision in the Nonmanufacturer Rule, the use of
    reverse-auctions, federal agency use of joint venture and
    teaming qualifications and surety improvement.

        My name is James Hoffman and I am President of Summer
    Consultants, a consulting mechanical, electrical, and plumbing
    engineering firm located in McLean, Virginia. Summer
    Consultants is a Small Business with 30 employees. We are
    committed to providing our clients sound engineering designs
    for various sized projects. Our practice focuses on the federal
    market and we have worked on many federal projects in the past
    50 years.

        My firm is an active member of ACEC - the voice of
    America's engineering industry. ACEC's over 5,000 member firms
    employ more than 380,000 engineers, architects, land surveyors,
    and other professionals, responsible for more than $500 billion
    of private and public works annually. Almost 85% of these firms
    are small businesses. Our industry has significant impact on
    the performance and costs of our nation's infrastructure and
    facilities.

        We are at a critical juncture in our nation's history as
    the risk to the public is growing at an alarming rate, as there
    has been ongoing neglect of the nation's infrastructure. At the
    same time, we are coming out of the largest economic crisis
    that affected all professional engineering firms. The
    construction industry, which bore the brunt of the recession,
    is finally coming back to fiscal health. Procurement
    improvements that facilitate greater efficiency for both the
    industry and the government will help these entities create
    better public infrastructure while increasing good paying jobs.

        Design-Build Improvement

        Design-build is a method of construction where engineers
    team with other industry professionals on proposed work. It
    requires the design team, comprised of engineers and
    architects, to develop detailed drawings and specifications for
    the contractor so that construction suppliers can submit
    detailed prices for the final proposal. This method has become
    popular in recent years and the federal government has moved to
    expand its use in construction.\1\
    ---------------------------------------------------------------------------
        \1\ Press Release, H. Comm. on Small Bus, Graves, Hanna Introduce
    Bipartisan Legislation to Benefit Small Construction Contractors. (July
    19, 2013) (on file with author).

        There are two forms of design-build procurement: two-step
    and one-step. Two-step design-build requires that teams submit
    relatively inexpensive qualifications packages to the
    contracting officer in the first round. The contracting officer
    reviews the qualifications and notifies the teams if they are
    selected for the next phase. In the second round, the design
    team develops expensive detailed and extensive plans for the
    contractor to use in their bidding. The design group develops
    these plans, generally without any reimbursement by the federal
    government or other participants, resulting in firms risking
    funds to participate in the project.\2\
    ---------------------------------------------------------------------------
        \2\ Building America: Challenges for Small Construction
    Contractors: Hearing Before the Subcomm. on Contracting & Workforce of
    the H. Comm. on Small Bus 113th Cong. 113-109 (2013). (statement of
    Helene Combs Dreiling, President, the American Institute of
    Architects).

        It is the industry standard for three to five finalists to
    be in the second round. However, in recent years, industry has
    reported often more than 10 finalists in that round. The
    current civilian statute states that the federal contracting
    officer should follow the industry standard, but the officer,
    at her or his own discretion, may increase the number of
    finalists when it is ``in the Federal Government's interest and
    is consistent with the purposes and objectives of the two-phase
    selection process.'' \3\ This exception causes issues for both
    the industry and for the contracting officer. Industry is
    risking greater exposure as more firms; small, medium, and
    large, are spending valuable resources developing expensive
    plans and specifications that have a lower chance for a
    successful bid. The contracting officer must review each of the
    plans and be prepared to give feedback to each team that does
    not win the project. With the increase in finalists, the
    government spends more time on proposal review, and introduces
    greater opportunity for errors or underbidding which impacts
    the project later. This issue has driven many, including small
    businesses, to stay out of the federal market. This makes the
    market less competitive and drives down industry participation.
    ---------------------------------------------------------------------------
        \3\ 41 U.S.C. 3309(d).

        One-step design-build creates an even more precarious
    environment for the industry as the qualifications step is
    eliminated. ACEC is staunchly opposed to this form of
    procurement as it eliminates the qualifications process,
    increases cost for all participants, and reduces market
    participation for engineers. One-step design-build allows the
    owner to solicit complete proposals from the construction
    market without a review of the team's past performance and
    qualifications. This mechanism forces teams to compete in large
    pools without any focus on technical capability, quality, or
    savings within the design. Due to this type of unqualified
    competition, many firms cannot justify the expenditures to
    compete against an unknown pool of applicants. This selection
    forces out small firms as they cannot spend valuable marketing
    dollars on projects where there are too many competitors--many
    of which that may not have the qualifications for the project.
    It is an inefficient process for the federal government as it
    asks contracting officers to review multitudes of proposals
    without the framework of qualifications to focus the
    evaluation. The U.S. Corps of Engineers has taken steps
    recently to limit one-step design-build, requiring high level,
    advanced approval for any projects over $750,000.\4\ When the
    government's largest construction agency implements limits on
    the process, other agencies should follow their precedent.
    ---------------------------------------------------------------------------
        \4\ James Dalton, PES, Limitations on the Use of One-Step Selection
    Procedures for Design-Build, Directive No. 2012-23 (2012) (on file with
    the author).

        Chairman Hanna held a haring on this issue on May 23, 2013
    and the House Oversight and Government Reform Subcommittee on
    Federal Workforce, US Postal Service and Census, also held a
    hearing on this issue on December 3, 2013. Former Small
    Business Committee Chairman Graves sponsored H.R. 2750, the
    Design-Build Jobs and Efficiency Act of 2013, which was amended
    into the National Defense Authorization Act (NDAA) of 2015. The
    NDAA implemented a limitation on military design-build
    procurements over $4 million whereby the contracting officer
    must ask for permission to expand the finalist pool in a two-
    phase procurement beyond five finalists. However, the
    limitations including the prohibition on one-step design-build,
    reporting on any exceptions to the five finalists, or any
    limitations for either single or two-step design build were not
    extended to the federal civilian market. The Congressional
    Budget Office (CBO) found that H.R. 2750 ``would not have a
    significant net effect on the federal budget'' \5\ in their
    analysis of the bill. CBO determined that it would help to
    ``analyze fewer construction bids'' \6\ which would balance any
    additional costs that may be involved in the bill. We ask the
    Committee to continue to pursue the proposed efficiencies found
    in H.R. 2750, which will help small businesses compete in the
    federal market, while also harmonizing the language between
    military and civilian design-build construction.
    ---------------------------------------------------------------------------
        \5\ Matthew Pickford, Cong. Budget Office, H.R. 2750 Design-Build
    Efficiency and Jobs Act of 2014 (2014), available at http://
    www.cbo.gov/sites/default/files/hr2750.pdf.
        \6\ Id.

    ---------------------------------------------------------------------------
        Proposed Nonmanufacturer Rule Changes

        The updated interpretation of the Nonmanufacturer Rule
    (NMR) poses a challenge for the construction industry as it is
    a service industry that typically did not have to address this
    rule in the past. The NMR exists to ensure that when
    competition for a contract for goods is restricted to small
    businesses that the good ultimately purchased was from a small
    business. Otherwise, the government risks restricting
    competition only to have the awardee provide a product it has
    simply passed along from a large manufacturer or international
    contractor. In a recent Court of Federal Claims ruling on
    Rotech Healthcare, Inc. v. United States \7\, the Court changed
    the common understanding of the rule. The Court found that the
    Small Business Act references ``any procurement for goods'' and
    that the SBA must apply that interpretation broadly across both
    services and commodities \8\.
    ---------------------------------------------------------------------------
        \7\ Case No. 14-502C (September 19, 2014)
        \8\ Id. at 6-8.

        ACEC has grave concerns with this interpretation.
    Currently, over 85 percent of all construction dollars are
    subcontracted to third parties.\9\ The Court's interpretation
    would require that any firm who is a prime contractor be
    responsible for their subcontractors' use of small business
    products. The paperwork burden on this concept is staggering.
    An example of the unintended result of this rule could require
    that engineering firms use paper made by small businesses to
    print out their correspondence for a federal construction job.
    Many businesses do not know who made their paper nor do firm
    owners concern themselves with the small business aspect of its
    production. The interpretation could require that the ink and
    any other materials, like specialized seismic machinery, that
    are not exempted through the regulations, must be obtained
    through a small business. The result of this ruling cannot be
    implemented without great cost to the businesses who work on
    and the taxpayers who fund federal construction projects.
    ---------------------------------------------------------------------------
        \9\ 13 C.F.R. Sec. 125.6.

        Second, in many instances, specific items may be
    manufactured in a foreign country. If an engineer specifies a
    part that has a foreign origin, or is made by a large
    manufacturer, it is most often because of necessary performance
    specifications that are essential to the project's long-term
    success. This ruling would have the engineer concerned with
    minutiae that is not relevant the responsibilities outlined
    above. This decision will result in the inefficient and
    wasteful use of taxpayer funds. ACEC asks the Committee to work
    with the SBA on language to make sure that construction
    ---------------------------------------------------------------------------
    services and products continue to be excluded from the NMR.

        Reverse Actions

        Reverse auctions are on-line sales where the bidders
    compete for work by lowering their price against other
    competitors in a specified time.\10\ Typically, agencies pay a
    variable fee, ``which is no more than 3 percent of the winning
    bid'' \11\ to the reverse action contractor. Reverse auctions
    force design professionals to bid on price, which is strictly
    prohibited by the Brooks Act and by many state professional
    licensing standards. It also fails to encourage any participant
    in the design and construction industry to focus on providing
    innovative and strategic solutions to the nation's
    infrastructure. It forces the competitors to focus solely on
    lowering their price. This often leads to errors or
    underbidding during the auction, without the ability to verify
    costs with subcontractors, who are often small businesses. The
    potential damage to a construction project and firms involved
    can be significant as project costs may increase beyond the bid
    or businesses could go out of business due to a mistake in the
    frenzy of bidding. Also of consideration is the fact that over
    ``a third of the...2012 reverse auctions...had not interactive
    bidding'' \12\ which means that no other vendor drove down the
    price. In short, the competition was sole-sourced out to a
    single bidder.
    ---------------------------------------------------------------------------
        \10\ U.S. Gov't Accountability Office, GAO-14-108 Reverse
    Actions--Guidance Is Needed to Maximize Competition and
    Achieve Cost Savings 6 (2004).
        \11\ Id. at 19.
        \12\ Id. at 26.

        Reverse actions have been used by the federal government in
    the past with commodities, with a noted lack of success in
    construction. The U.S. Corps of Engineers conducted a year-long
    study whereby they found that reverse auctions ``offered not
    even marginal edge in savings over the sealed bid process for
    construction service projects'' \13\. The Corps found that
    sealed bids for construction, typically the domain of
    contractors, was a better method than reverse auctions.\14\
    Moreover, former OFPP Administrator Mr. Joseph Jordan, who is
    the current FedBid CEO stated, ``An agency might want to use
    FedBid to find a contractor to paint a wall, he said, but not
    to construct an office building.'' \15\ It is telling that both
    the Corps and the third-party vendor for reverse auctions do
    not advocate their use in construction.
    ---------------------------------------------------------------------------
        \13\ USACE, Final Report regarding the USACE Pilot Program on
    Reverse Auctioning 34-37 (2004).
        \14\ ACEC advocates for qualifications based selection (QBS) in the
    selection of the architect and engineer, but that is not the subject of
    this hearing.
        \15\ Danielle Ivory, `Reverse Actions' Draw Scrutiny, N.Y. Times,
    April 6, 2014 at B1.

        H.R. 2751, the Commonsense Construction Contracting Act of
    2013, introduced by Rep. Richard Hanna (R-NY), sought to
    restrict the use of so-called reverse auctions as a means of
    procuring construction and design-related services. Like H.R.
    2750, it was incorporated into the NDAA, but the prohibition
    was limited to the use of reverse auctions in design-build
    procurements. At this time, there are no programs that can be
    found by the industry that used this procurement method. While
    federal procurement law already prohibits the use of reverse
    auctions for engineering activities, we view the full
    legislation as necessary to protect firms of all sizes in our
    industry when they provide services in support of construction
    efforts. ACEC asks the committee to reintroduce H.R. 2751, to
    build stronger prohibitions against the use of this commodities
    ---------------------------------------------------------------------------
    based program for construction services.

        Joint Venture Rules

        Joint ventures and teams are important to construction and
    small businesses in the federal market.\16\ Teams are important
    to the design-build process as each discipline works together
    to compete on construction projects. Joint ventures allow for
    organizations new to federal procurement to work with
    experienced partners to gain entry to the market. It is
    important for teams to add or change firms to enhance their
    qualifications, to offer the best services for a particular
    project in the pre-competition phase. These practices allow the
    federal government to obtain innovative private sector talent
    while also increasing capable competition on federal projects.
    ---------------------------------------------------------------------------
        \16\ Joint ventures and teams are used interchangeably in this
    submission. Joint ventures are contractual relationships between
    entities while teams are groups of professionals working together
    towards a single project. They are very similar in nature, but differ
    in the legal sense.

        Current law states that small businesses may ``submit an
    offer that provides for the use of a particular team of
    subcontractors for the performance of the contract'' \17\ and
    that requires the contract be evaluated, ``in the same manner
    as other offers, with due consideration for the capabilities of
    all proposed subcontractors.'' \18\ There are recent reports
    that some agencies are requiring joint ventures or teams to
    present joint past performance in their qualification. This
    practice demonstrates that some contracting officers do not
    understand the rationale and benefit of teaming. Some agencies
    require that ``an [o]fferor must have proven experience and
    performance as an existing CTA (Contractor Team Arrangement) in
    the form of a Partnership or Joint Venture in accordance with
    the proposal submission requirements' \19\, or that past
    performance may only be considered if it is that of ``a parent
    company, affiliate, division, and/or subsidiary.'' \20\ Under
    present statute, the contracting officer must look at the
    qualifications of the individual organizations comprising a
    team rather than the past performance of the group as a whole.
    Requiring that the team have common past performance reviews
    discourages the use of new teams, new partners, and the
    inclusion of new small businesses in the federal market.
    ---------------------------------------------------------------------------
        \17\ Id.

        \18\ Id. at Sec. 15(e)(4), 15 U.S.C. Sec. 644(e)(4).

        \19\ GSA OASIS Request for Proposal (2013) available at http://
    www.fbo.gov/
    ?s=opportunity&mode=form&tab=core&id=df05de3d9c9cafle7943d278094eefbl&--
    cview=1.
        \20\ HCaTS RFI APPENDIX 3 - DRAFT RFP SECTION L (2015) (on file
    with author).

        ACEC strongly encourages the Committee to amend the Small
    Business Act to protect the development of joint ventures and
    teams. Federal agencies are losing their opportunity for
    innovation and small business participation when contracting
    ---------------------------------------------------------------------------
    rules are not followed by federal agencies.

        Surety Improvements

        A surety is a third party product that guarantees payment
    if one party defaults on the agreement. In federal
    construction, there are two key bonds--payment bonds and
    performance bonds. The Miller Act requires that the contractor
    must provide a surety for payment and performance bonds on
    contracts greater than $150,000. This provides performance
    protection to the federal government that the taxpayer will not
    be damaged if the contractor fails to complete a project, while
    also guaranteeing payment to subcontractors if the contractor
    defaults. H.R. 776, the Security in Bonding Act of 2013, was
    introduced by Chairman Hanna to address the issues of bonding
    availability for small businesses and problems with individual
    surety guarantees. The bill increases the guarantee rate for
    the Preferred Surety Bond Program, which will help more small
    business obtain a bond at a reasonable rate, and requires
    verifiable collateral for the issuance of surety bonds. While
    ACEC members typically do not obtain surety bonds, with the
    exception of some of our larger members who are also
    construction contractors, we recognize the importance of this
    product for the taxpayer and the subcontractors. ACEC asks the
    Committee to reintroduce H.R. 776 in this Congress.

        Conclusions and Recommendations

        The engineering services industry is unique in how firms
    are established, perform work, selected for the project, and
    work with each other. Most firms in the industry are small,
    specialized, and have a business plan to remain that way to
    assure performance and reputation. These factors result in the
    need for special considerations when trying to ensure
    appropriate small business participation in federal
    procurements.

        We ask that the committee consider the following actions
    for the 114th Congress:

               Reintroduce H.R. 2750 and enact it into law.

               Work with the SBA on appropriate language to
            limit the scope of the NMR on service industries.

               Reintroduce H.R. 2751 and enact it into law.

               Strengthen the Joint Venture and teaming
            past performance rules.

               Reintroduce H.R. 776 and enact it into law.

        ACEC and I thank the Committee for the privilege and
    opportunity to address engineering and construction industry
    issues with current federal procurement and I am pleased to
    answer any questions.
    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

                          MCAA Statement on the Use of

                         Internet Reverse Auctions for

                             Construction Services

        MCAA considers the use of Internet reverse auctions for
    procurement of construction services to be problematic for
    owners and contractors alike.

        While most applications of various e-commerce and Internet
    use (project websites, for example) have demonstrated or hold
    great promise for productivity and service improvements for
    owners and the industry at large, the same cannot be said for
    Internet reverse auctions. MCAA considers them to be little
    more than a form of electronic bid shopping; that is,
    disclosing the proprietary bid price of a competitor to all
    others for the purpose of obtaining even lower bids.

        While reverse auctions may be judged appropriate by some
    owners for certain well defined projects on a case-by-case
    basis, an across-the-board policy dictating reverse auction,
    price-only selection for all projects would be just as short
    sighted as dictating a single type of project delivery system
    for projects of all types.

        MCAA, along with the industry overall, long ago recognized
    the long-term detrimental impact of an across-the-board policy
    of low-bid, price-only selection criteria, and the bid shopping
    and chopping practices that are inherent in that system and
    undermine project success, such as: fragmented scopes of work
    and scope disputes, unnecessary changes and inordinate delays,
    and overhead waste relating to defensive contract
    administration, claims, disputes and lawsuits.

        In fact, many of the innovations in construction
    procurement, contracting and project administration over the
    past 20 years have been in direct response to the
    inefficiencies that stem from low-bid, price-only selection
    criteria. Those innovations include value-based selection
    criteria, careful past performance evaluations,
    prequalification screening of competitors, project partnering,
    integrated project contracting and delivery systems, design-
    build services delivery, and other positive contract
    administration procedures, including dispute avoidance
    mechanisms and measures to reduce project dispute overhead
    costs. Overall, these developments have represented a better
    investment in overall project quality and life-cycle cost
    effectiveness.

        Unfortunately, Internet reverse auctions can be seen as a
    way to adapt new technology to return to many of the problems
    of the past and give back the project efficiency gains that
    have resulted from innovative, value-added contracting
    procedures. Nevertheless, given recent experience with reverse
    auctions, MCAA members have encountered certain approaches that
    tend to ameliorate the more difficult aspects of the process as
    discussed below.

        > Well-defined scope of work - Reverse auctions are least
    likely to lead to problem jobs in those cases where the owner
    has firm, detailed design drawings and specifications. Recent
    studies strongly indicate that project planning up front is the
    best predictor of project success and problem avoidance.

        > Use of best-value prequalification criteria - Best-value
    prequalification criteria should be rigorously applied. The
    criteria should include demonstrated superior past performance
    related to project performance overall, including cost and
    schedule delivery, project safety experience, workforce
    training and development investments, and project management
    and site supervision expertise relating to equipment purchasing
    and other aspects of contract administration.

        > Transparency of auction procedures - The reverse auction
    procedures should provide maximum transparency in the interest
    of fairness for all competitors. The identity of all
    participants should be disclosed, as well as the dollar amount
    and ranking of all bids. Similarly, the owner should disclose
    the existence and amount of any reserved price above which the
    project would not be let. Just as laws pertaining to the
    auctions of goods are designed to protect fairness in the
    process and prevent fraud and abuse, the owner and Internet
    service provider for reverse auctions of construction contracts
    should make sure that all competitors are extended the same
    privileges under the auction rules.

        > Provide adequate procedures for redress of errors - The
    auction procedures should provide careful safeguards against
    both imprudent and administrative mistakes in bidding, as
    overall project success is strongly compromised by mistakes in
    selection decisions. Even at this early stage, it is widely
    recognized that the reverse auction process often tempts hasty
    and imprudent bidding given the tight time frame and
    competitive context of the auction procedure. The industry
    recognizes that selection based on competitive frenzy as
    opposed to more discerning judgment is a high risk factor for
    project success. Bid decrements and the time intervals for bid
    adjustments should be appropriate for the scope and size of the
    project. Clerical mistakes also should be excused in the
    auction process in the manner of treatment of those mistakes in
    the sealed bidding context. Overall the owner should not design
    the process as though construction service auctions can be
    conducted in the same way as commodities procurement.

        > Provide adequate safeguards against other abuses - The
    reverse auction procedures should also contain adequate
    safeguards against fraud and abuse, including express
    warranties against fictitous (``phantom bidders'') bidders and
    other conditions that would constitute fraud in the inducement
    of the contract award. Moreover, any procedure for post-bid
    negotiated awards should be disclosed up front so competitors
    can fairly judge whether they can afford to compete. Similarly,
    if post-bid price increases are to be permitted, that too
    should be disclosed up front.

        > Policy reservations - Notwithstanding adherence to the
    suggestions listed above, MCAA member experience suggests that
    reverse auctions remain a relatively new, untested and unproven
    method to actually lower construction costs without
    compromising project success.

        MCAA contractor experience with Internet reverse auctions
    suggests that the last bid in a reverse auction is not always
    the lowest and best price that may have been submitted even
    under sealed bidding procedures. Owners should be aware that a
    comparison of the opening bid with the last bid is not a valid
    indicator of actual cost savings on the project. Moreover,
    while open competition is good policy generally, even with
    careful prequalification screening, the auction process prompts
    fast and furious competitive judgments more than prudent
    decision-making. Negative experiences could significantly
    shrink the pool of willing competitors, and deliver negative
    project outcomes.

        In conclusion, early experience suggests that the risks of
    mistakes, misjudgments and the added costs of Internet services
    may well in many cases outweigh the perceived costs savings
    realized through the use of reverse auctions.

        MCAA will continue to monitor experience with reverse
    auctions for a continuing factual assessment of their costs and
    benefits and effect on project outcomes.

        Footnote - This statement does not address the many ways
    that public and private contracting practices vary with respect
    to contractor selection rules and procedures generally and
    reverse auctions in particular. In the main, Federal, state,
    and local open competition/sealed bidding rules prohibit
    reverse auctions for construction. The Federal procurement
    policy is to continue to use sealed bidding/competitive
    negotiations without price disclosure for construction
    services, even though one agency has Congressional
    authorization to test pilot reverse auctions. Another agency is
    attempting to categorize some construction/repair/alteration
    projects as ``commercial items'' to avoid construction
    procurement rules. At the state level, a growing number of
    states are amending procurement laws to permit reverse auctions
    for commodities, but are careful to rule out reverse auctions
    for construction services.

        Approved by the MCAA Board of Directors, February 28, 2004
        [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        INTRODUCTION

        Chairman Chabot, Ranking Member Velaazquez and members of
    the committee, thank you for holding this hearing examining
    contracting and the industrial base. Further, thank you for the
    opportunity for the Design-Build Institute of America (DBIA) to
    submit the following testimony.

        DBIA is an institute representing leaders in the design and
    construction industry utilizing design-build and integrated
    project delivery methods to achieve cost and time savings on
    high performance projects. DBIA promotes the value of design-
    build project delivery and teaches the effective integration of
    design and construction services to ensure success for owners
    and design and construction practitioners in the delivery of
    projects from all sectors in communities across the country.
    Since we are design-build professionals focused on defining and
    teaching best practices, we will limit our comments today to
    the ``failure to properly use a two-step procurement process
    for design-build contracts'', as indicated in the February 5,
    2015 hearing announcement.

        WHAT IS DESIGN-BUILD?

        Design-Build is a method of project delivery in which one
    entity - the design-build team - works under a single contract
    with the project owner to provide design and construction
    services. With design-build there is one entity with a single
    point of responsibility, one contract, one unified flow of work
    from initial concept through completion - thereby integrating
    the roles of designer and constructor.

        Design-build is a more efficient and better quality
    alternative to the traditional design-bid-build project
    delivery method. Under the traditional approach, design and
    construction services are split into separate entities,
    separate contracts, and separate work.
    [GRAPHIC] [TIFF OMITTED] T3326.020

        Design-build project delivery provides benefits for both
    owners and practitioners. Owners experience faster delivery,
    cost savings and better quality than with other contracting
    methods. Research shows costs can be six percent lower with
    project delivery speed increased by as much as one-third \1\.
    ---------------------------------------------------------------------------
        \1\ Construction Industry Institute (CII)/Penn State 1999

        Further, dealing with a single entity decreases owners'
    administrative burden and allows them to focus on the project,
    rather than managing separate contracts. The approach also
    reduces their risk and results in fewer litigation claims for
    ---------------------------------------------------------------------------
    all parties involved.

        Practitioners reap the benefits of a higher profit margin
    since an integrated team is fully and equally committed to
    controlling costs. Like owners, the design-builder benefits
    from a decreased administrative burden because the
    communication between designers and builders is streamlined.

        The advantages of design-build have become clear in recent
    years which is why today nearly 40% of all non-residential
    construction in the U.S. is done design-build, with the
    military using it for more 80% of its construction \2\.
    ---------------------------------------------------------------------------
        \2\ Design-build Project Delivery Market Share and Market Size
    Report, RS Means, May 2014

    ---------------------------------------------------------------------------
        SINGLE-STEP VS. TWO-STEP DESIGN-BUILD

        Federal regulation allows for the use of design-build
    project delivery, including both a single-step process and a
    two-step process. In the single-step process, a request for
    proposals (RFP) is issued for a project. It is issued to an
    unlimited number of participants and any and all parties can
    respond with a proposal. A selection process is then used to
    determine the proposal that is best from both a cost and
    technical perspective.

        In a two-step process a request for qualifications (RFQ) is
    first issued, and any and all participants then respond with a
    statement of qualifications. The RFQ response is a relatively
    simple and inexpensive procedure where the design-build teams
    submits, for example, documents detailing their past
    performance, staff resumes, and examples of similar projects
    they've completed. Based on these statements a short list of
    three to five of most qualified respondents is determined. The
    RFP is then issued only to these ``shortlisted'' firms which
    then develop full proposals including cost, schedule, and
    technical response.

        Small Business Are Far Better Served By the Two-Step
    Process

        In a single-step process, all design-build teams are asked
    to spend time and resources creating detailed proposals
    immediately, as opposed to simply submitting their
    qualifications. Due to the high costs of this first step -
    often reaching hundreds of thousands of dollars or even
    millions - many design-build teams decide not to apply since
    their chances of final selection are so low. Small businesses
    in particular do not have the luxury to spend limited resources
    to apply for a project when the chance of being chosen may be
    less than ten percent.

        If small businesses were only required to initially provide
    their qualifications under the two-step process, as opposed to
    a full proposal under the single-step process, many more would
    be able to participate. This is not only good for American
    small businesses, it also benefits the federal government and
    the American taxpayer who can be sure the most qualified
    design-build teams were not scared away from a project simply
    due to the costs and risks of applying.

        Consider and Pass the Design-Build Efficiency and Jobs Act

        During the 113th Congress, legislation endorsed by DBIA,
    the Design-Build Efficiency and Jobs Act (H.R. 2750) was
    introduced by Congressman Graves and a version passed the House
    of Representatives. This bill was written to limit the use of
    single-step design-build procedures, and assure the proper use
    of two-step procedures as originally mandated by Congress. That
    legislation should be reintroduced, considered and passed into
    law.

        H.R. 2750 would have done two primary things:

              1. To limit the use of single-step, H.R. 2750 would
            have limited its use to projects that are less than
            $750,000. This threshold is based on U.S. Army Corps of
            Engineers guidance which was issued in August 2012.
            Further, it will assure that for larger more complex
            projects risks for all firms are held in check, thus
            allowing small firms a greater chance to compete in the
            marketplace.

              2. H.R. 2750 also would have encouraged better use of
            the preferred two-step procedures and by requiring
            agencies to better justify and report when their
            agencies short-list more than five finalists on a
            specific project in the two-step process.

        CONCLUSION

        Thank you again for the opportunity to submit this
    statement. We look forward to working with this committee on
    improving design-build procedures so the advantages of design-
    build delivery can be more fully realized and American small
    business can thrive.

        We are ready to answer any questions you may have.
        [GRAPHIC NOT AVAILABLE IN TIFF FORMAT]

        The National Association of Surety Bond Producers (NASBP)
    is a national trade association of firms employing licensed
    surety bond producers who place bid, performance, and payment
    bonds throughout the United States and its territories.

        The Surety & Fidelity Association of America (SFAA) is a
    District of Columbia non-profit corporation whose members are
    engaged in the business of suretyship. SFAA member companies
    collectively write the majority of surety and fidelity bonds in
    the United States. The SFAA is licensed as a rating or advisory
    organization in all states, as well as in the District Columbia
    and Puerto Rico, and it has been designated by state insurance
    departments as a statistical agent for the reporting of
    fidelity and surety data.

        Our written statement begins with a brief description of
    the important role surety bonds play in the federal procurement
    arena. Our statement then addresses our support of three bills
    introduced in the 112th and 113th Congresses, H.R. 3534 and
    H.R. 776, and H.R. 838. H.R. 838 was introduced in the 114th
    Congress on February 10, 2015, by Representative Richard Hanna,
    and cosponsored by the Chairman of the House Small Business
    Committee, Steve Chabot and Representative Grace Meng. These
    bills concern the use of individual surety bonds on federal
    construction projects and reforms to the Small Business
    Administration's (SBA) Surety Bond Guarantee Program, and are
    representative of needed legislation on small business matters
    that NASBP and SFAA wish to bring to the attention of the
    Committee on Small Business for support.

        The Importance of Surety Bonds: Sound Public Policy

        Corporate surety bonds are three-party contract agreements
    by which one party (a surety company) guarantees or promises a
    second party (the obligee/federal government) the successful
    performance of an obligation by a third party (the principal/
    contractor). In deciding to grant surety credit, the surety
    underwriter conducts in-depth analysis, also known as
    prequalification, of the capital, capacity, and character of
    the construction firm during the underwriting process to
    determine the contractor's ability to fulfill contractual
    commitments. Surety bonds are an essential means to discern
    qualified construction companies and to guarantee contracts and
    payments, ensuring that vital public projects are completed,
    subcontracting entities are paid, and jobs are preserved.

        The federal government has relied on surety bonds for
    prequalification of construction contractors and for
    performance and payment assurance since the late nineteenth
    century. In 1894, the U.S. Congress passed the Heard Act which
    codified the requirement for surety on U.S. government
    contracts and institutionalized the business of surety. In
    1935, the Heard Act was superseded by the Miller Act, which
    required the continuation of these vital assurances so that
    U.S. taxpayer funds were protected and subcontractors and
    suppliers would receive payment for their labor and materials.
    Currently, the federal Miller Act requires performance and
    payment bonds from prime contractors awarded construction
    contracts exceeding $150,000.00, and payment security for
    contracts between $30,000.00 and $150,000.00.

        Types of Surety Bonds

        The bid bond assures that the bed has been submitted in
    good faith and the contractor will enter into the contract at
    the bid price and provide the required performance and payment
    bonds. A performance bond protects the project owner from
    financial loss should the contractor fail to perform the
    contract in accordance with its terms and conditions. The
    payment bond protects subcontractors and suppliers, which do
    not have direct contractural agreements with the public owner
    and which would be unable to recover lost wages or expenses
    should the contractor be unable to pay its financial
    obligations. Often, small construction businesses must access
    the federal procurement marketplace at subcontractor and
    supplier levels, and the payment bond is their primary recourse
    and protection in the event of prime contractor nonpayment or
    insolvency.

        The Construction Industry Supports of H.R. 3534 (112th
    Congress) H.R. 776 (113th Congress) and H.R. 838 (114th
    Congress)

        NASBP and SFAA along with many other organizations such as:
    the American Council of Engineering Companies (ACEC), the
    Associated General Contractors of America (AGC), the American
    Institute of Architects (AIA), the American Subcontractors
    Association (ASA), the Mechanical Contractors Association of
    America (MCAA), the Sheet Metal and Air Conditioning
    Contractors' National Association (SMACNA), the Construction
    Financial Management Association (CFMA), and the American
    Insurance Association (AIA), view H.R. 3534, H.R. 776, and H.R.
    838 as critical means (1) to protect taxpayers, federal
    contracting entities, and construction businesses by assuring
    the integrity of surety bonds on federal contracts when issued
    by unlicensed individuals using a pledge of assets and (2) to
    provide additional opportunities for small and emerging
    construction contractors, which otherwise do not qualify for
    surety credit in the standard market, to utilize the Surety
    Bond Guarantee Program of the US Small Business Administration,
    so that such businesses will receive surety credit from
    regulated markets.

        Enact legislation to protect taxpayers, and small
    businesses

        Every contractor that bids and obtains a federal
    construction contract must secure its obligations under that
    contract. The most common form of security is a surety bond
    from a certified and approved surety insurance company. As
    noted earlier, the Federal Miller Act requires contractors to
    furnish surety bonds on federal construction projects to ensure
    that prospective contractors are qualified to undertake federal
    construction contracts and that bonded contracts will be
    completed in the event of a contractor default, thereby
    protecting precious U.S. taxpayer dollars and subcontractors
    and suppliers, many of which are small businesses. The
    financial strength and stability of the surety is the key to
    the success of the surety bonding system.

        Presently, there are three methods construction firms may
    use to furnish security on a federal construction project:

              1. By securing a bond written by a corporate surety,
            that is vetted, approved, and audited by the U.S.
            Department of Treasury and listed in its Circular 570;

              2. By using their own assets to post an ``eligible
            obligation,'' i.e. a U.S.-backed security, in lieu of a
            surety bond. The security is pledged directly and
            deposited with the federal government until the
            contractor is complete; or

              3. By securing a bond from an unlicensed individual,
            if the bond is secured by an ``acceptable asset,''
            which includes stocks, bonds, and real property owned
            in fee simple.

        It is this third alternative that has proven consistently
    problematic to the financial detriment of contracting
    authorities and of subcontractors and suppliers performing on
    federal projects. NASBP, SFAA, along with the other
    organizations supporting these bills, believe, based on
    substantial evidence and past testimony, that the current
    regulations pertaining to use of individual sureties on federal
    construction projects are fundamentally flawed, allowing
    gamesmanship by unlicensed persons acting as sureties. Such
    existing requirements need to be superseded by the statutory
    approach delineated in H.R. 3534/776/838.

        Federal Acquisition Regulation (FAR) 28.203-2(b)(3) permits
    federal contracting officers to accept bonds from natural
    persons, not companies, if the bond is secured by an
    ``acceptable asset,'' which includes stocks, bonds, and real
    property. These individuals neither are subject to the same
    scrutiny and vetting given to corporate sureties nor are they
    required to provide physical custody of the asset to the
    government that they pledge to secure their bonds to the
    contracting authority.

        This lack of thorough scrutiny of individual sureties and
    control over their pledged assets has resulted in a number of
    documented situations where assets pledged by individual
    sureties have proven to be illusory or insufficient, causing
    significant financial harm to the federal government, to
    taxpayers, and to subcontractors and suppliers, many of whom
    are small businesses wholly reliant on the protections of
    payment bonds to safeguard their businesses.

        Federal requirements do mandate a level of documentation
    and information from individual sureties. Individual sureties
    are required to complete, sign, and have notarized an affidavit
    of individual surety (SF 28), which is a standardized form for
    the purpose of eliciting a description of the assets pledged
    and the contracts on which they are pledged. SF 28, however,
    does not elicit other pertinent information, such as that about
    the character or fitness of the individual acting as surety,
    like criminal convictions, state insurance commissioner cease
    and desist orders, outstanding tax liens, or personal
    bankruptcies.

        Under FAR requirements, the pledged assets also are
    supposed to be placed in an escrow arrangement by the
    individual surety, subject to the approval of the contracting
    officer. The individual surety, however, is not required to
    turn the assets over to the physical care and custody of the
    contracting authority. Each contracting officer, not the
    Department of Treasury, shoulders the entire burden of
    determining the acceptability of the individual surety, its
    documentation, the escrow or security arrangement, and the
    value and adequacy of pledged assets, and must do so in
    relatively short order to progress the contract procurement. A
    missed, incorrect, or forsaken step may mean the acceptance of
    a fraudulent or insufficient bond, rendering its apparent and
    much needed protection worthless.

        This burden of assessing individual sureties is added to
    the already considerable responsibilities of contracting
    officers. They are required to determine the authenticity of
    the documentation of the assets pledged to support the
    individual surety's bond obligations and to verify that the
    pledged assets actually exist, are sufficient, and are
    available to the federal government. They have to know that a
    particular financial document is what it purports to be and to
    understand and to assess the different types of collateral,
    such as stocks and real estate located anywhere in the United
    States.

        It is not clear if and how often federal contracting
    officers receive specific training to understand and to perform
    the needed tasks of examination concerning individual sureties.
    Documents of federal agencies suggest that there are occasions
    when federal contracting officers may not have a complete
    understanding of what is required of them to safeguard
    taxpayers and small businesses from individual surety fraud.
    The Financial Management Service of the U.S. Department of
    Treasury issued a ``Special Informational Notice to All Bond-
    Approving (Contracting) Officers'' \1\ on February 3, 2006,
    still posted at http://www.fiscal.treasury.gov/fsreports/ref/
    suretyBnd/special--notice.pdf. This informational
    notice was directed to federal contracting officers to remind
    them of the applicable FAR requirements governing individual
    sureties. Specifically, the notice, a copy of which is attached
    to this testimony, states in part:
    ---------------------------------------------------------------------------
        \1\ United States Treasury Department. Financial Management
    Service. ``Special Informational Notice to All Bond-Approving
    (Contracting) Officers''. February 3, 2006.

              ``Although FMS is not substantively responsible for
            approving individual sureties, we believe it prudent to
            issue this Special Informational Notice on a FYI basis
            to Agency Bond-Approving (Contracting) Officers who do
    ---------------------------------------------------------------------------
            have that responsibility under the FAR.

              Recently, FMS has been made aware of instances where
            individual sureties are listing corporate debenture
            notes and other questionable assets on their `Affidavit
            of Individual Surety', Standard Form 28. In some
            instances, the individual sureties used a form other
            than the Standard Form 28 as their affidavit.''

        Likewise, the U.S. Department of the Interior issued a
    notice to its contracting officers in 2009 to remind them of
    FAR requirements associated with acceptance of individual
    surety bonds. This notice, titled ``Department of the Interior
    Acquisition Policy Release (DIAPR) 2009-15,'' states that the
    Department of the Interior Office of Inspector General
    conducted an investigation of contracting personnel practices
    concerning individual sureties and found concerns.\2\
    Specifically, the release, a copy of which is attached to this
    testimony, states in part:
    ---------------------------------------------------------------------------
        \2\ United States. Department of the Interior. ``Department of the
    Interior Acquisition Policy Release (DIAPR) 2009-15''. September 8,
    2009.

              ``The investigation identified several areas of
            concern that require our attention. There is concern
            that Contracting Officers (COs) are: (1) unfamiliar
            with the FAR requirements for individual surety; (2)
            accepting individual surety bonds without knowing or
            verifying the assets backing the bonds; (3) not vetting
            questions about individual surety bonds through the DOI
            Office of the Solicitor; and (4) not verifying
            individual sureties against the General Services
    ---------------------------------------------------------------------------
            Administration's Excluded Parties List System.''

        If a contracting officer fails to perform adequately the
    necessary investigation of an individual surety, and the
    individual surety pledges assets that do not exist, are
    insufficient, or are not readily convertible into cash to pay
    the obligations of the defaulted general contractor, everyone
    on the project from the contracting agency on down is left
    unprotected and at risk for financial loss. If the assets
    pledged to support the bonds are uncollectible, unpaid
    subcontractors and suppliers protected by the bond, many of
    which typically are small businesses, will suffer financial
    hardship and could, in turn, default and become insolvent.

        Examples of Improper Individual Surety Activity

        There is no one place to go to find statistical data on
    individual surety problems because individual sureties
    typically operate outside of state insurance regulatory
    structures, despite the fact that they are required under
    almost all state insurance codes to obtain certificates of
    authority to act as a surety insurer from state insurance
    commissioners. Moreover, the federal government does not
    require individual sureties writing bonds on federal contracts
    to furnish proof of licensure or authority to operate in a
    state jurisdiction as a surety insurer. Consequently, little or
    no regulatory oversight may ever be exercised over persons
    acting as individual sureties on federal projects apart from
    the modicum of scrutiny undertaken, if at all, by the federal
    contracting officer.

        Nonetheless, in recent years, illustrations of individual
    surety problems abound. These situations usually involve
    individual surety bond assets that turned out to be inadequate,
    illusory, or unacceptable. One illustration is United States ex
    rel. JBlanco Enterprises Inc. v. ABBA Bonding, Inc, where, in
    spite of a March 11, 2005 cease and desist order from the
    Alabama Insurance Department, Mr. Morris Sears, doing business
    as ABBA Bonding, was able to submit bonds on a federal contract
    in Colorado supported by an affidavit (Standard Form 28)
    stating that ABBA Bonding had assets with a net worth of over
    $126 million. Although no assets were placed in escrow for the
    benefit of the government, the U.S. General Services
    Administration accepted the bonds anyway. JBlanco Enterprises,
    a small business 8a subcontractor performing work on federal
    contracts, nearly was forced to declare bankruptcy as a result
    of a deficient individual surety bond placed by Mr. Sears on a
    federal project that later proved to have no assets to support
    the bond. Ms. Jeanette Wellers, a principal of JBlanco
    Enterprises, provided oral and written testimony \3\ about this
    situation during a hearing on H.R. 3534.
    ---------------------------------------------------------------------------
        \3\ Wellers, Jeanette. Written Testimony before U.S. House
    Committee on the Judiciary Subcommittee on Courts, Commercial and
    Administrative Law. March 5, 2012.

        Sears eventually sought bankruptcy protection against
    numerous creditors (100+) arising from defaulted bond
    obligations, including protection against bond debts owed to
    three federal contracting agencies. Chief Bankruptcy Judge
    Margaret A. Mahoney, U.S. Bankruptcy Court, Southern District
    of Alabama held that Sears had ``knowingly made
    misrepresentations regarding collateral he pledged in support
    of surety bonds.'' \4\ Judge Mahoney also found that Sears
    falsely stated that the real estate had not been pledged to any
    other bond contract within three years prior to the execution
    of any Affidavit and that Sears made misrepresentations to
    numerous agencies. Thus, the Bankruptcy Court determined that
    the Sears' debts to the government were nondischargeable. His
    false statements then formed the basis of a criminal indictment
    against Sears, who died while undergoing criminal prosecution
    in the U.S. District Court for the South District of Alabama.
    ---------------------------------------------------------------------------
        \4\ United States. Department of Justice. US Attorney's Office.
    Southern District of Alabama. ``Pennsacola Man Indicted in Government
    Contract Survey Bond Fraud Scheme''. June 28, 2012.

        In another example, Edmund Scarborough, the owner of IBCS
    Fidelity, another individual surety, filed for bankruptcy in
    Tampa, Florida. IBCS issued countless individual surety bonds
    on federal, state, and private construction projects using
    suspect assets. In his bankruptcy petition, Scarborough listed
    $4.5 million in assets and $16.2 million in liabilities; IBCS
    had used a speculative commodity, mined coal waste, which it
    valued at $191 million, to back its individual surety bonds.
    That mined coal waste was valued at $120,000 in the bankruptcy
    filing.\5\
    ---------------------------------------------------------------------------
        \5\ Richard Korman, Controversial Individual Surety Files for
    Bankruptcy Protection, Engineering News-Record, August 5, 2014
    available at: http://enr.construction.com/
    business--management/finance/2014/0805-Outspoken-Individual-
    Surety-Files-for-Bankruptcy-Protection.asp?

        The above individuals operated nationally and across state
    boundaries, victimizing public and private entities, small
    construction businesses, and businesses of all sizes. These
    examples, unfortunately, are not isolated instances. Other
    examples exist, both past and present, showing where individual
    surety bond assets proved illusory, uncollectible, or
    deficient. More businesses, many of whom are likely to be small
    businesses, will be victimized unless Congress acts to correct
    these flawed requirements, which permit unscrupulous
    individuals, many with criminal, personal insolvency, and tax
    lien histories, to issue worthless surety bonds on taxpayer-
    ---------------------------------------------------------------------------
    funded federal construction contracts.

        Common-Sense Legislative Solution

        Legislation like H.R. 3534, H.R. 776, and H.R. 838 are
    simple, common-sense legislative solutions that will eliminate
    opportunities for fraud by mandating that real assets be placed
    in the care and custody of the contracting authority. These
    bills require individual sureties to pledge solely those assets
    defined as eligible obligations by the Secretary of the
    Treasury. An eligible obligation is a public debt obligation of
    the U.S. Government and an obligation whose principal and
    interest is unconditionally guaranteed by the U.S. Government,
    such as U.S. Treasury bills, notes, and bonds, certain HUD
    government guaranteed notes and certificates, and certain
    Ginnie Mae securities, among other federally guaranteed
    securities. These safe and stable assets then are provided to
    the federal contracting authority, which will deposit them in a
    federal depository designated by the Secretary of the Treasury,
    ensuring that pledged assets are real, sufficient, convertible,
    and in the physical custody and control of the federal
    government. This is nothing more than what now is statutorily
    required of contractors who wish to pledge collateral as
    security on a federal contract in lieu of a surety bond.

        If enacted, it would eliminate the gamesmanship and
    opportunities for fraud endemic in the current regulatory
    system governing individual surety bonds and pledged assets and
    will remove a considerable administrative burden from federal
    contracting officers. Federal contracting officers no longer
    will need to assess a range of pledged assets, as all pledged
    assets will be limited to assets unconditionally guaranteed by
    the federal government; they simply will need to gain custody
    over the asset to deposit the asset in a federal depository,
    such as the Federal Reserve Bank, St. Louis. The asset will be
    released upon successful performance of the bonded obligation,
    with any accrued interest inuring to the benefit of the
    individual surety pledging the government-backed asset.

        Construction businesses working on a construction project--
    either as subcontractors, suppliers, or workers on the job--
    have no control over the prime contractor's choice of security
    provided to the federal government, but they suffer the most
    harm financially if the provided security proves illusory. The
    impact is particularly acute on small construction businesses,
    which may not have the strength to weather a significant
    disruption to their cash flow. Passage of legislation like such
    as H.R. 838 will mean that contracting agencies and the
    numerous subcontractors and suppliers on federal construction
    projects, in the event of a performance or payment default will
    know that adequate and reliable security is in place to
    guarantee that they will be paid for their valid claims.

        Increase the Guarantee to 90% for Surety Companies in SBA
    Program

        Background

        The U.S. Small Business Administration's (SBA) Surety Bond
    Guarantee Program (Program) was created to ensure that small
    and emerging contractors who do not qualify for surety credit
    in the standard market have the opportunity to bid on public
    construction work, grow their businesses and remain a viable
    part of the U.S. economy. Small businesses must have access to
    these bonds to obtain federal construction contracts after a
    certain dollar threshold, and the Program assists them in
    obtaining these bonds.

        As the Program has evolved, there are two plans under which
    sureties can participate in the Program. The Prior Approval
    Program (Plan A) was the original SBA bond guarantee program.
    In this Program, the surety must obtain SBA approval for each
    bond prior to writing the SBA guaranteed bond. The SBA maximum
    indemnification of the surety's loss as a result of a bond
    claim in Plan A is 80%, and 90% for bonds written for socially
    and economically disadvantaged contractors and bonds written
    for contracts under $100,000. The second program is the
    Preferred Surety Bond Program (Plan B). Under this plan,
    sureties apply to participate, submitting information up front
    on their underwriting practices and financial strength. Once a
    surety becomes a participant in Plan B, it is given an
    aggregate limit of bonds that it can write within the Program.
    As long as the surety complies with all of the requirements of
    Plan B, all bonds written within the Program qualify for
    reimbursement of losses. The SBA does not review or approve
    each individual bond before it is written and the guarantee
    attaches. In Plan B the surety receives a maximum 70%
    indemnification.

        Enhancements to Program

        Over the years, the Program has gone through several
    enhancements to increase participation and remove burdensome
    regulatory requirements. For example, a provision in the 2013
    National Defense Authorization Act (NDAA) increased the
    guarantee limit from $2 million to $6.5 million to align the
    Program with the simplified acquisition threshold and with the
    needs of other SBA small business contracting programs, such as
    the 8a Minority Small Business and Capital Ownership
    Development Program. Additional reforms will provide greater
    enhancement opportunities for small businesses and to ensure
    participation from sureties.

        Legislative Recommendation

        NASBP and SFAA recommend amending Section 411(c)(1) of the
    Small Business Investment Act of 1958 (15 U.S.C. 694b(c)(1)) by
    increasing the guarantees afforded to surety companies that
    participate in the Program from 70% to 90%. This revision will
    likely stimulate greater corporate surety and surety bond
    producer participation, providing access to the corporate
    surety markets to small businesses which otherwise do not
    qualify for surety credit in the standard market. These small
    businesses are often the ones that may turn to unlicensed
    individual sureties, where they can be duped by unscrupulous
    persons seeking vulnerable businesses and offering surety
    credit to anyone, regardless of the firm's qualifications,
    financial wherewithal, or experience, and at rates many times
    higher than the filed rates charged by corporate surety
    markets.

        No Added Cost to the Government or Risk to Taxpayers

        According to the 2014 House Small Business Committee Report
    (REPT. 113-462, Part 2, pgs. 5-6) the Congressional Budget
    Office (CBO) ``estimates that implementing this change would
    not have a significant effect on discretionary spending because
    we expect the agency would raise fees to cover any additional
    costs arising from the higher guarantee percentage. Enacting
    such legislation would not affect direct spending or revenues;
    therefore, pay-as-you-go procedures would not apply.''

        According to the SBA Office of Surety Guarantees, increased
    liability to the government does not seem to be a significant
    issue. Under the 2009 American Recovery and Reinvestment Act
    (ARRA), the SBA issued 218 final surety bonds for a contract
    value of $663 million, which resulted in only two defaults. The
    National Defense Authorization Act for Fiscal Year 2013
    increased the eligible contract amount to $6.5 million, and up
    to $10 million with a Federal contracting officer's
    certification that the guarantee is necessary for the small
    business to obtain bonding. Since the increase in contract size
    amount, SBA has guaranteed over 170 total bonds with a contract
    value of over $500 million, which have resulted in no defaults.

        Conclusion

        NASBP and SFAA appreciate the opportunity to provide the
    Committee with information about the compelling need to enact
    legislation such as H.R. 838: (1) to protect taxpayer funds and
    construction businesses performing as subcontractors and
    suppliers on federal construction contracts and (2) to provide
    small businesses with greater access to regulated surety
    markets through the SBA Surety Bond Guarantees Program. NASBP
    and SFAA hope this statement proves beneficial and welcomes any
    inquiries from the Committee on the points raised in this
    written testimony or on other matters pertinent to small
    businesses and surety bonding.

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