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


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                 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

                               __________

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            Small Business Committee Document Number 114-001
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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

[GRAPHICS NOT AVAILABLE IN TIFF FORMAT] 

                                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\
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    \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\
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    \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.

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    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\.
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    \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 
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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

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    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.
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    \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-
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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.

                                 [all]