Defense Contract Management: DOD's Lack of Adherence to Key	 
Contracting Principles on Iraq Oil Contract Put Government	 
Interests at Risk (31-JUL-07, GAO-07-839).			 
                                                                 
The Department of Defense's (DOD) U.S. Army Corps of Engineers	 
(Corps) awarded the $2.5 billion Restore Iraqi Oil (RIO I)	 
contract to Kellogg Brown & Root in March 2003 in an effort to	 
reestablish Iraq's oil infrastructure. The contract was also used
to ensure adequate fuel supplies inside Iraq. RIO I was a	 
cost-plus-award-fee type contract that provided for payment of	 
the contractor's costs, a fixed fee determined at inception of	 
the contract, and a potential award fee. The Defense Contract	 
Audit Agency (DCAA) reviewed the 10 RIO I task orders and	 
questioned $221 million in contractor costs. We were asked to	 
determine (1) how DOD addressed DCAA's RIO I audit findings and  
what factors contributed to DOD's decision and (2) the extent to 
which DOD paid award fees for RIO I and followed the planned	 
process for making that decision. To accomplish this, we reviewed
DOD and DCAA documents related to RIO I and interviewed Corps,	 
DCAA, and other officials.					 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-839 					        
    ACCNO:   A73751						        
  TITLE:     Defense Contract Management: DOD's Lack of Adherence to  
Key Contracting Principles on Iraq Oil Contract Put Government	 
Interests at Risk						 
     DATE:   07/31/2007 
  SUBJECT:   Audit reports					 
	     Contract administration				 
	     Contract negotiations				 
	     Contractor payments				 
	     Cost plus award fee contracts			 
	     Defense audits					 
	     Defense procurement				 
	     Department of Defense contractors			 
	     Evaluation criteria				 
	     Internal audits					 
	     Questionable procurement charges			 
	     Requirements definition				 

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GAO-07-839

   

     * [1]Results in Brief
     * [2]Background
     * [3]Delayed Negotiations Shaped DOD's Decision to Pay the Contra

          * [4]DOD Decided to Pay the Contractor for Nearly All of the $221
          * [5]Delays in Negotiations Influenced the Contracting Officer's
          * [6]Changing Requirements, Funding Challenges, and Inadequate Co
          * [7]DCAA Attributes $26 Million in Cost Reductions on the RIO I
          * [8]The Sustention Rates on the DCAA Audits of the RIO I Contrac

     * [9]DOD Paid About Half of the Maximum Possible Award Fee for th

          * [10]DOD Paid Approximately $57 Million in Award Fees for the RIO
          * [11]DOD Missed Opportunities to Motivate Contractor Performance
          * [12]DOD Could Not Provide Sufficient Documentation to Enable Us
          * [13]The Percentage of Award Fee Earned on the RIO I Contract Fel

     * [14]Conclusion
     * [15]Recommendation for Executive Action
     * [16]Agency Comments and Our Evaluation
     * [17]GAO's Mission
     * [18]Obtaining Copies of GAO Reports and Testimony

          * [19]Order by Mail or Phone

     * [20]To Report Fraud, Waste, and Abuse in Federal Programs
     * [21]Congressional Relations
     * [22]Public Affairs

Report to Congressional Requesters

United States Government Accountability Office

GAO

July 2007

DEFENSE CONTRACT MANAGEMENT

DOD's Lack of Adherence to Key Contracting Principles on Iraq Oil Contract
Put Government Interests at Risk

GAO-07-839

Contents

Letter 1

Results in Brief 3
Background 5
Delayed Negotiations Shaped DOD's Decision to Pay the Contractor for
Nearly All of the Costs Questioned on the RIO I Contract 9
DOD Paid About Half of the Maximum Possible Award Fee for the RIO I
Contract, but Did Not Fully Adhere to Key Steps in Its Award Fee Plan for
Providing Performance Feedback to the Contractor 23
Conclusion 29
Recommendation for Executive Action 30
Agency Comments and Our Evaluation 30
Appendix I Objectives, Scope, and Methodology 32
Appendix II Comments from the Department of Defense 34

Tables

Table 1: GAO's Analysis of the Resolution of DCAA's Questioned Costs 12
Table 2: DCAA's Questioned Costs Sustained on the RIO I Contract Audits 21
Table 3: Award Fee Paid for RIO I Task Orders 24

Figures

Figure 1: Reasons for DCAA Questioned Costs 8
Figure 2: Elapsed Days from Notice to Proceed to Definitization 15
Figure 3: Comparison of Sustention Rates 22
Figure 4: Percentage of Award Fee Earned on the RIO I Contract and on 11
Other Selected Iraq Reconstruction Contracts from January 2004 to June
2006 29

Abbreviations

DCAA Defense Contract Audit Agency
DESC Defense Energy Support Center
DFARS Defense Federal Acquisition Regulation Supplement
DOD Department of Defense
DFI Development Fund for Iraq
FAR Federal Acquisition Regulation
RIO Restore Iraqi Oil

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United States Government Accountability Office
Washington, DC 20548

July 31, 2007

The Honorable Henry A. Waxman
Chairman
The Honorable Tom Davis
Ranking Member
Committee on Oversight and Government Reform
House of Representatives

The Honorable Daniel K. Akaka
Chair
Subcommittee on Oversight of Government Management,
the Federal Workforce, and the District of Columbia
Committee on Homeland Security and Governmental Affairs
United States Senate

The United States, along with its coalition partners and various
international organizations and donors, has embarked on a significant
effort to rebuild Iraq. As of October 2006, the United States had
obligated about $29 billion for reconstruction and stabilization efforts
in Iraq. The United States has relied heavily on private sector
contractors to provide the goods and services needed to support
reconstruction efforts in Iraq. For example, to help reestablish Iraq's
oil infrastructure, in March 2003 the U.S. Army Corps of Engineers (Corps)
awarded the Restore Iraqi Oil (RIO I) contract to Kellogg Brown & Root.1
The contract was also used to import fuels from neighboring countries to
avoid domestic fuel shortages in Iraq. Under this contract, the Corps
issued 10 task orders worth approximately $2.5 billion. The RIO I
contract, like many other reconstruction and support contracts, was a
cost-plus-award-fee type contract. In general, these contracts provide for
payment of the contractor's allowable, allocable, and reasonable costs; a
fixed base fee amount determined at inception of the contract; and a
potential award fee sufficient to provide motivation for excellence in
contract performance. A cost-plus-award-fee contract, like other cost
reimbursement type contracts, increases the risk to the government of
incurring higher than expected costs, as compared to some other contract
types. To mitigate this risk, these types of contracts require sufficient
oversight.

1 Kellogg Brown & Root is now known as KBR.

The Defense Contract Audit Agency (DCAA) provides services that can help
the Department of Defense (DOD) ensure accountability for its
acquisitions. DCAA performs audits and provides financial advisory
services in connection with the negotiation, administration, and
settlement of contracts and subcontracts. For example, DCAA has audited
many Iraq contract proposals and contracts and has identified costs it
considers to be questioned. DCAA defines questioned costs as those costs
that are not acceptable for negotiating a fair and reasonable contract
price. Ultimately, the contracting officer has the final decision about
whether questioned costs should be paid, taking into account DCAA's advice
and other information. On the RIO I contract, DCAA identified $221 million
in questioned costs in its final audits of the task order proposals under
the contract.

Because of your interest in understanding the final agreement reached
between DOD and the contractor on the RIO I contract, we examined (1) how
DOD addressed DCAA's audit findings on the contract and what factors
contributed to DOD's decision of how to address these findings and (2) the
extent to which DOD paid award fees for the contract and followed the
planned process for making that decision.

To determine how DOD addressed DCAA's audit findings on the RIO I contract
and the factors that contributed to DOD's decision of how to address those
findings, we reviewed negotiation memorandums and DCAA audit reports for
each of the 10 RIO I task orders and other documents related to the
negotiation process and resolution of DCAA's findings. We also interviewed
Corps, DCAA, and other government officials as well as contractor
representatives. Additionally, to put DOD's decisions into context, we
compared the resolution of DCAA's questioned cost findings on 100 audits
of Iraq-related contract actions that were resolved as of the end of
fiscal year 2006 to the resolution of the questioned cost findings on the
RIO I task order audits. Because a contracting officer has the discretion
to determine whether or not to pay questioned costs when reaching
agreement with a contractor, our review does not include a determination
of whether the DOD contracting officer should have approved payment for
the questioned costs.

To determine the extent to which DOD paid award fees for the RIO I
contract and followed its planned process for making that decision, we
collected and reviewed key documents related to the award fee process,
including the award fee determining official's decision and the award fee
plan. We also interviewed Corps officials to develop an understanding of
the process and outcome for the award fees and contractor representatives
to obtain their perspective on award fees. Additionally, to put the award
fee for the RIO I contract into context, we examined available award fee
documentation for 11 large contracts that DOD awarded in 2004 to carry out
reconstruction activities in Iraq. During the period we looked at, January
2004 through June 2006, a total of 37 award fee evaluation periods were
conducted for the 11 contracts. Because an award fee determination is a
unilateral decision made solely at the discretion of the government based
upon judgmental evaluations of individual contractor performance, our
review does not include a determination of whether DOD reached the
appropriate award fee decision for the RIO I contract. Appendix I provides
details on our scope and methodology. We conducted our work from October
2006 through July 2007 in accordance with generally accepted government
auditing standards.

Results in Brief

DOD considered DCAA's audit findings on the RIO I contract and performed
additional analysis before deciding to pay the contractor nearly all of
the $221 million in costs that DCAA questioned, a decision influenced by
the fact that negotiations of the task orders' terms and conditions did
not begin until most of the work was complete. DOD also removed about $112
million of the questioned costs from the amount used to establish the
contractor's fee pool, which resulted in an effective lowering of the fee
received by the contractor by approximately $5.8 million. Lack of timely
negotiations was a major contributing factor to DOD's decision on how to
address the questioned costs. Although the Defense Federal Acquisition
Regulation Supplement (DFARS) generally requires that contract actions be
definitized within 180 days after issuance of the action, all 10 task
orders were negotiated more than 180 days after the work commenced. As a
result, the contractor had incurred nearly all costs at the time of
negotiations, and this fact influenced the DOD contracting officer's
decision to pay most of the questioned costs. According to various DOD
officials and contractor representatives, changing requirements, funding
challenges, and inadequate contractor proposals contributed to the
negotiation delays. These findings are consistent with our previous work,
where we found that factors such as changing requirements and difficulties
with funding were linked to delays in definitization, and that these
delays can increase risk to the government. Overall, DCAA considers $26
million of the costs questioned on the RIO I contract to be sustained,
which DCAA defines as cost reductions directly attributable to its audit
findings. We compared the sustention rates on DCAA's 11 RIO I contract
audits to the sustention rates for 100 DCAA audits of other Iraq contract
actions, and found that the sustention rates varied widely for both
groups.

DOD's Army Corps of Engineers paid about $57 million in award fees, or 52
percent of the maximum possible award fees, on the RIO I contract, but it
did not adhere to some key steps in its planned award fee process related
to providing performance feedback to the contractor. The award fee paid
varied by task order, ranging from 4 percent to 72 percent of the possible
award fee. DOD developed an award fee plan that laid out the steps for
making its award fee decision, but it did not fully adhere to that plan.
For example, the plan required award fee evaluations on a regular basis
during the period of performance, but DOD did not conduct a formal
evaluation until July 2004, subsequent to the completion of nearly all
work on the contract. DOD officials told us the workload of RIO staff
members and logistical difficulties stemming from the challenging
conditions in Iraq hindered efforts to hold evaluation boards during the
period of performance. By not conducting such evaluations during the
period of performance, DOD was not able to provide the contractor with
formal award fee feedback while work was ongoing, which federal
regulations state should be done in order to motivate a contractor to
either improve poor performance or continue good performance.2
Additionally, DOD was not able to provide us with sufficient documentation
to enable us to fully assess its adherence to other steps of its plan. For
example, DOD did not have the scores the award fee board assigned to the
contractor on the individual award fee criteria in coming to its award fee
recommendation. Without these scores, we were unable to determine whether
the award fee board had followed the criteria and weighting laid out in
the contract in reaching its recommendation. We compared the percentage of
award fees earned on the RIO I contract to fees earned on a group of other
selected Iraq reconstruction contracts and found that the percentage of
award fee earned on the RIO I contract fell within the lower range of fees
earned on other contracts.

To ensure that cost-plus-award-fee contracts provide the intended
benefits, we are recommending to the Secretary of the Army that the
department conduct an analysis of the administrative feasibility of
following a rigorous award fee process before awarding a
cost-plus-award-fee contract in contingency situations. In written
comments, DOD agreed with the recommendation. DOD's comments are included
in appendix II.

2 Federal Acquisition Regulation (FAR) 16.405-2(b)(3).

Background

The United States, along with its coalition partners and various
international organizations and donors, has embarked on a significant
effort to rebuild Iraq. As of October 2006, the United States had
obligated about $29 billion for reconstruction and stabilization efforts
in Iraq. The United States has relied heavily on private sector
contractors to provide the goods and services needed to support the
reconstruction efforts in Iraq.

Congress has appropriated substantial amounts to support rebuilding
efforts such as restoring Iraq's oil and electric infrastructures,
assisting in developing a market-based economy, and improving the
country's health, education, and medical services. With regard to Iraq's
oil sector, U.S. support has included efforts to (1) restore Iraq's oil
infrastructure to sustainable prewar crude oil production and export
capacity, and (2) deliver and distribute refined fuels for domestic
consumption. Specific U.S. activities and projects for the restoration of
Iraq's oil production and export capacity include repairing the Al-Fathah
oil pipeline crossing, restoring several gas and/or oil separation plants
near Kirkuk and Basrah, and repairing natural gas and liquefied petroleum
gas plant facilities in southern Iraq. U.S. activities also include the
restoration of wells, pump stations, compressor stations, export
terminals, and refineries, and providing electrical power to many of these
oil facilities. In addition to infrastructure restoration activities, from
late May 2003 through August 2004, the United States facilitated and
oversaw the purchase, delivery, and distribution of refined fuels
throughout Iraq, primarily funded using the Development Fund for Iraq
(DFI).3 These imports--used for cooking, heating, personal transportation,
and private power generation--were required to supplement domestic
production due to increased demand and Iraq's limited refining capacity.

In early 2003, DOD assigned the Corps the responsibility of the oil
restoration activities known as Restore Iraqi Oil. In March 2003 the Corps
awarded a cost-plus-award-fee contract, referred to as the RIO I contract,
to support the oil restoration mission. Under this contract, the Corps
awarded 10 task orders to the contractor worth a total of $2.5 billion.
Two task orders related to oil restoration planning and extinguishing oil
fires; two task orders were for the construction and repair of the oil
infrastructure; one was for life support activities, such as lodging and
dining services; and five task orders were for the importation, delivery,
and distribution of refined fuels throughout Iraq.

3 On May 22, 2003, United Nations Security Council Resolution 1483 noted
the establishment of the Development Fund for Iraq, a special account held
on the books of the Central Bank of Iraq. The DFI includes frozen assets
of the former Iraqi regime and Iraq oil proceeds. The DFI was to be used
for the economic reconstruction and repair of Iraq's infrastructure, among
other purposes.

At the request of the Corps, DCAA audited the contractor's proposals for
the RIO I contract.4 DCAA performs many types of audits for DOD, including
audits of contractor proposals, audits of estimating and accounting
systems, and incurred cost audits. Generally, the results of DCAA audits
of contractor proposals are intended to assist contracting officials in
negotiating reasonable contract prices. Typically, DCAA audits
contractors' proposals and provides contracting officials advice on the
reasonableness of contractor costs prior to negotiations. DCAA also
conducts audits of cost-type contracts after they are negotiated to ensure
costs incurred on these contracts are acceptable. Relying on cost
information provided by the contractor and assessing whether the costs
comply with government regulations, DCAA may identify certain costs as
questioned. DCAA defines questioned costs as costs considered to be not
acceptable for negotiating a fair and reasonable contract price. DCAA
reports its findings to contracting officers for consideration in
negotiating fair and reasonable contract prices.

DCAA audit reports represent one way DCAA can assist contracting officials
as they negotiate government contracts. Also, contracting officials may
invite DCAA to participate in contract negotiations to explain audit
findings and recommendations. DCAA's role is advisory, and the contracting
officer is responsible for ensuring that the contractor's proposed price
is fair and reasonable.5 While DCAA audit recommendations are nonbinding,
federal regulations specify that when significant audit recommendations
are not adopted, the contracting officer should provide rationale that
supports the negotiation result in the price negotiation documentation.6

In its final 11 audits of the 10 task orders, DCAA identified $221 million
in questioned costs on the RIO I contract. In total, DCAA issued 22
proposal audits of the RIO I contract because DCAA audited multiple
proposals for some of the task orders. The final 11 audits included one
audit of each task order and an audit of a contractor claim on the life
support task order. 7 Nearly 80 percent of the questioned costs related to
the costs paid for fuel and fuel delivery. For example, DCAA questioned
$139 million of the costs the contractor paid for fuel and fuel
transportation in Kuwait based on a comparison of the price paid by the
contractor and the price paid by the Defense Energy Support Center (DESC)
when it took over the mission for the contractor in April 2004. Figure 1
outlines the reasons for DCAA's questioned costs on the RIO I contract.

4 These proposals were intended to definitize the contractual actions and
were generally submitted after the contractor had incurred some of its
costs.

5 Federal Acquisition Regulation 1.602-2(c), 15.402(a).

6 Federal Acquisition Regulation 15.405(a).

7 More than 99 percent of DCAA's questioned costs were on task orders 3,
5-10, and the contractor claim for task order 4, all of which were
negotiated by one DOD contracting officer. Another DOD contracting officer
negotiated the other three task orders. Report references to the DOD
contracting officer refer to the contracting officer who decided how to
address nearly all of the questioned costs.

Figure 1: Reasons for DCAA Questioned Costs

Note: Numbers do not add to 100 percent due to rounding.

The RIO I contract provided for payment of a fixed fee of 2 percent of the
negotiated estimated contract cost plus an award fee amount of up to 5
percent, based on the government's evaluation of the contractor's
performance. Award fee contracts allow an agency to adjust the amount of
fee paid based on contractor performance.8 The award fee is intended to
motivate excellence in contractor performance, and can also serve as a
tool to control program risk and cost. However, the monitoring and
evaluation of contractor performance necessary under an award fee contract
requires additional administrative effort and cost, and federal
regulations provide that the use of such a contract is suitable when the
expected benefits of an award fee contract are sufficient to warrant this
additional effort and cost.9

8 GAO recently reviewed DOD's use of award and incentive fees. See GAO,
Defense Acquisitions: DOD Has Paid Billions in Award and Incentive Fees
Regardless of Acquisition Outcomes, [23]GAO-06-66 (Washington, D.C.: Dec.
19, 2005).

9 Federal Acquisition Regulation 16.405-2(b)(iii).

In general, for award fee contracts, DOD personnel (usually members of an
award fee evaluation board) conduct periodic evaluations of the
contractor's performance against specified criteria in an award fee plan
and recommend the amount of fee to be paid. These evaluations are informed
by input provided by government personnel who directly observe the
contractor's performance. Typically, award fee contracts emphasize
multiple aspects of contractor performance, such as quality, timeliness,
technical ingenuity, and cost-effective management. Because award fees are
intended to motivate contractor performance in areas that are susceptible
to judgmental and qualitative measurement and evaluation, these criteria
and evaluations tend to be subjective. After receiving the recommendation
of the award fee evaluation board, a fee-determining official makes the
final decision on the amount of fee the contractor will receive. In
certain cases the fee-determining official may also decide to move
unearned award fee from one evaluation period to a subsequent evaluation
period or periods, thus providing the contractor an additional opportunity
to earn previously unearned fee--a practice called rollover.10

Delayed Negotiations Shaped DOD's Decision to Pay the Contractor for Nearly All
of the Costs Questioned on the RIO I Contract

DOD considered DCAA's audit findings and conducted additional analysis
before deciding to pay the RIO I contractor nearly all of the $221 million
in costs that DCAA questioned, and to remove $112 million from the amount
used to establish the contractor's fixed and award fees. The reduction in
the amount used to establish the fee pool resulted in an effective
reduction of the contractor's fee by about $5.8 million. DOD's decision to
pay most questioned costs was shaped by the fact that negotiations did not
begin until most of the work was complete and the costs had already been
incurred. The delay in negotiations was influenced by factors such as
changing requirements, funding challenges, and problems with the
contractor's business systems. DCAA considers $26 million of the costs
questioned on the RIO I contract to be sustained, which DCAA defines as
cost reductions directly attributable to its questioned cost findings. We
compared the sustention rates on DCAA's 11 RIO I contract audits to the
sustention rates for 100 DCAA audits of other Iraq contract actions, and
found that the sustention rates varied widely for both groups.

10 In a March 2006 policy memo, DOD established limitations on the use of
award fee rollover provisions, including that the use of rollover
provisions should be the exception rather than the rule and is a business
decision that should be addressed in the acquisition strategy. According
to the memo, if the fee-determining official approves the use of rollover,
the contract file must be documented accordingly.

DOD Decided to Pay the Contractor for Nearly All of the $221 Million in DCAA
Questioned Costs, but Removed $112 Million from the Amount Used to Establish the
Contractor's Fee on the RIO I Contract

To address the $221 million in costs questioned by DCAA, DOD collected
additional information and conducted additional analysis. For example,
after DCAA issued its final audits, DOD collected additional information
related to the difference in costs paid by the contractor and those paid
by DESC for fuel and fuel delivery from Kuwait, as well as price
adjustments the contractor paid to the subcontractor for fuel from Turkey,
the two largest reasons for questioned costs. The DOD contracting officer
also convened a meeting with contractor representatives, DCAA officials,
and other Corps officials to discuss the additional information. As a
result of the additional information and analysis presented in the
meeting, the DOD contracting officer asked DCAA to conduct financial
analyses to quantify options--referred to as financial positions--that he
could use in developing the government's objectives for negotiations with
the contractor. The financial positions differed from DCAA's final audit
reports in some areas, for example, reflecting a narrower gap between the
costs paid by the contractor and the costs paid by DESC for the fuel and
fuel delivery from Kuwait.11

DOD decided to address the $221 million in questioned costs in the
following ways:

           o Pay both the costs and fees. The DOD contracting officer decided
           to pay the contractor costs and associated fees for nearly half of
           the costs questioned by DCAA. In general, these costs reflected
           the financial positions prepared for negotiations by DCAA after
           DOD collected additional information about some of the questioned
           costs. For example, although DCAA's final audits questioned the
           costs paid for fuel from Turkey, the financial positions did not
           include reductions for these costs. The contracting officer used
           the financial positions as a basis for deciding to pay the
           contractor for the costs for fuel from Turkey.

           o Not pay the contractor costs or fees. For less than $10 million
           of the questioned costs, DOD decided not to pay the contractor for
           its costs and the associated fees. For example, the Corps decided
           not to reimburse approximately $4 million the contractor spent on
           leasing diesel trucks that were not used.

           o Pay the costs but not the fees. For almost half of the
           questioned costs, DOD decided to pay the contractor but removed
           those costs from the amount used to calculate the contractor's
           fee. These costs were composed primarily of the difference that
           remained between the prices paid by the contractor and by DESC for
           fuel and fuel delivery from Kuwait after the contracting officer
           took into account the financial positions.

11 DCAA officials told us the memos that outlined the financial positions
do not supercede DCAA's final audit reports, but were provided to the
contracting officer to assist with negotiations.

When asked about the reason for paying for questioned costs but removing
those same costs from the amount used to establish the contractor's fee,
the DOD contracting officer told us that this outcome was a result of
negotiations. He stated that while the contractor probably did not do
everything it could have to lower prices, it took reasonable actions to do
so. For example, Corps officials stated that the contractor attempted to
obtain lower prices for the fuel and fuel delivery from Kuwait through
competition on several occasions. Also, the officials told us that DOD
decided to pay for these questioned costs because it felt that it would
have been unlikely to prevail in an attempt not to pay costs that had
already been incurred by the contractor. Specifically, Corps officials
told us they believed that in the event of litigation, they would have
been ordered to pay the contractor for incurred costs because, for
example, the Corps continually directed the contractor to perform work
under the contract.12 However, these officials told us they believed there
was adequate justification to negotiate the exclusion of some questioned
costs from fee eligibility.

The DOD contracting officer also believed there were several limitations
to the primary reason for DCAA's questioned costs--the comparison of the
price paid by the contractor for fuel and fuel delivery from Kuwait to the
price paid by DESC, which took over the fuel importation mission in 2004.
Specifically, the contracting officer attributed the contractor's higher
price to factors such as the Kuwaiti subcontractor's perception of the
risk of working in Iraq, short-term subcontracts for the fuel and fuel
delivery because of the incremental funding provided, and differences in
overhead costs. DESC officials also told us there were several factors
that limited the usefulness of the comparison between the prices paid by
DESC and the prices paid by the contractor for fuel and fuel delivery from
Kuwait, such as the fact that DESC could commit to longer contracts with
the Kuwaiti subcontractor and the fact that by contracting with the same
subcontractor, DESC could use the fuel transportation infrastructure
established under the prior contract (i.e., the start-up costs faced by
DESC were lower).

12 The decision to pay the questioned costs rather than assume the
litigative risk and attendant costs associated with defending a claim for
disallowance of incurred costs is essentially a matter of the contracting
officer's business judgment. See FAR 1.602-2.

In total, $112 million of the questioned costs were removed from the
amount used to establish the contractor's fee pool. The contractor's fixed
and award fees were calculated as a percentage of the costs included in
the fee pool. Consequently, removing $112 million from the amount used to
establish the fee pool resulted in an effective lowering of the fees the
contractor received by about $5.8 million (see table 1 for details).13

Table 1: GAO's Analysis of the Resolution of DCAA's Questioned Costs

Dollars in 
thousands  
                                                       Changes   
                                                      resulting  
                                                     from DCAA's 
                                                     questioned  
                                                        costs    
                                                                    Effective 
                                                                          fee 
                                                                  adjustments 
                                                     Adjustments    resulting 
                                                          to the from changes 
                                                     amount used       to the 
                              Primary                         to   amountused 
                              reason for        DCAA   establish           to 
                              questioned  questioned     the fee establishthe 
Task order Purpose         costs            costs       poola    fee poolb 
1          Pre-positioning Differences                                     
              and training    between                                         
                              proposed                                        
                              and actual                                      
                              costs             $904       -$904         -$38 
2          Quick fix       Differences                                     
              design          between                                         
                              proposed                                        
                              and actual                                      
                              costs              200        -197          -11 
3          Infrastructure  Costs not                                       
              repair and      allocable                                       
              restoration     to task                                         
                              order           11,698      -4,830         -184 
4          Life support    Indirect                                        
                              costs due                                       
                              to rate and                                     
                              base                                            
                              differences         86      1,745c          66c 
4          Equitable       Indirect                                        
              adjustment      costs due                                       
              claim - life    to rate and                                     
              support         base                                            
                              differences         39         -39         N/Ad 
5          Fuel import and Kuwait and                                      
              distribution    Turkey fuel                                     
                              and fuel                                        
                              delivery                                        
                              charges         84,446     -45,129       -2,437 
6          Infrastructure  Timing of                                       
              repair and      obtaining                                       
              restoration     contracting                                     
                              officer                                         
                              consent         32,078      -5,289         -116 
7          Fuel import and Kuwait and                                      
              distribution    Turkey fuel                                     
                              and fuel                                        
                              delivery                                        
                              charges         35,681     -16,598         -896 
8          Fuel import and Kuwait and                                      
              distribution    Turkey fuel                                     
                              and fuel                                        
                              delivery                                        
                              charges         22,781     -14,562         -786 
9          Fuel import and Kuwait and                                      
              distribution    Turkey fuel                                     
                              and fuel                                        
                              delivery                                        
                              charges         19,903     -15,578         -841 
10         Fuel import and Kuwait and                                      
              distribution    Turkey fuel                                     
                              and fuel                                        
                              delivery                                        
                              charges         13,603     -10,782         -582 
Total                                    $221,418   -$112,163      -$5,826 

Source: GAO analysis of DOD data.

aNumbers in this column reflect our analysis of cost adjustments made to
the amount used to establish the fee pool as result of DCAA's questioned
costs. At negotiations, DOD also adjusted other contract costs not
resulting from DCAA's questioned costs, which are not reflected in this
table.

bNumbers in this column reflect our analysis of what would have happened
if DOD had applied the fixed and award fee percentages earned for each of
the task orders to the adjustments to the amount used to establish the fee
pool resulting from DCAA's questioned costs.

cCertain costs were questioned by DCAA based on the task order to which
they were allocated. The increase to the amount used to establish the fee
pool for task order 4 reflects allocation adjustments made based on DCAA's
findings associated with task order 3.

dBecause the equitable adjustment claim exceeded the not-to-exceed amount
for task order 4, the contracting officer decided that no fixed or award
fees would be paid on the claim.

13 We calculated the $5.8 million in the following manner: For each task
order, we multiplied the award and fixed fee percentages received by the
contractor by the adjustment to the amount used to establish the fee pool
(this amount totaled -$112 million across the task orders). We then summed
this total for each task order.

DCAA officials said they believed the DOD contracting officer followed the
standard process for addressing questioned costs. For example, the
Director of DCAA testified before Congress that the process worked as it
is defined, and that in making its decision of how to address the costs,
the Corps "rightly considered other evidence other than the audit reports
and considered extenuating circumstances that might have affected the
contractor's actions."14 When asked if he was satisfied with the
resolution of the questioned costs, a DCAA official involved in the
process told us he thought the DOD contracting officer did the best job he
could, given the circumstances.

14 Iraq Reconstruction: Hearing before the House Comm. on Oversight and
Government Reform, 110th Cong. (2007).

Delays in Negotiations Influenced the Contracting Officer's Decision to Pay
Questioned Costs

All 10 RIO I task orders were negotiated more than 180 days after the work
commenced, and all were negotiated after the work had been completed. The
RIO I task orders were considered undefinitized contracting actions
because DOD and the contractor had not reached agreement on the terms,
specifications, and price of the task orders before performance began.
Undefinitized contract actions are used when government interests demand
that the contractor be given a binding commitment so that work can begin
immediately, and negotiating a definitive contract is not possible in time
to meet the requirement. DOD requires that contract actions be definitized
within 180 days after issuance of the action or when the amount of funds
obligated under the action is over 50 percent of the not-to-exceed price,
whichever occurs first. The head of an agency may waive these limitations
in certain circumstances that likely would have applied for this contract,
including for a contingency operation, but Corps officials told us that
waivers were not requested for these task orders. Figure 2 shows the time
it took for DOD and the contractor to reach agreement on the terms and
conditions for the task orders. Because of the delays in negotiations,
virtually all of the costs had been incurred by the contractor at the time
of negotiations.

Figure 2: Elapsed Days from Notice to Proceed to Definitization

The contracting officer determined that the questioned costs he decided to
pay were reasonable and in accordance with the FAR, and his decision to
pay nearly all of the questioned costs was influenced by (1) the fact that
nearly all of the costs had been incurred at the time of negotiations and
(2) his belief that payment of incurred costs was required, absent unusual
circumstances.15 The contracting officer stated in final negotiation
documentation that unusual circumstances did not exist for most of the
questioned costs. For example, the DOD contracting officer indicated that
because DCAA chose not to suspend or disallow the funds, which DCAA can do
by issuing a Form 1, unusual circumstances did not exist. 16

Changing Requirements, Funding Challenges, and Inadequate Contractor Proposals
Contribute to Negotiation Delays and Increase Risk to the Government

Several factors contributed to the delay in negotiations, including DOD's
changing requirements, DOD's funding challenges, and inadequacies in
several of the contractor's business systems. Based on contract
documentation as well as interviews with DOD officials and contractor
representatives, these factors made it difficult for the contractor to
submit proposals in a timely fashion. Without a qualifying contractor
proposal, the government and the contractor are not able to reach
agreement on the terms and conditions of a task order.17 For many of the
task orders, the contractor did not submit qualifying proposals until late
in the period of performance or after the work had been completed. For
example, for 6 of the 10 task orders, the contractor did not submit a
qualifying proposal that was audited by DCAA until after the period of
performance was complete.

15 Under the FAR, there is no presumption of reasonableness when costs are
incurred by the contractor. If the contracting officer challenges a
specific cost, the contractor has the burden of proof to establish that
such cost is reasonable. A cost is reasonable if, in its nature and
amount, it does not exceed that which would be incurred by a prudent
person in the conduct of competitive business. What is reasonable depends
upon a variety of considerations and circumstances, including whether it
is the type of cost generally recognized as ordinary and necessary for the
conduct of the contractor's business or the contract performance. FAR
31.201-3. The contracting officer is allowed wide latitude to exercise
business judgment and could still decide to pay the costs after
consideration of the audit findings based on a judgment of what the best
business decision would be, including the desire to avoid the cost of
litigation.

16 Pursuant to the authority of DOD Directive 5105.36, DCAA can issue a
Form 1. A Form 1 constitutes notice of costs suspended and/or disapproved
incident to the audit of contractor costs incurred under a contract.
Suspended costs are costs that have been determined to be inadequately
supported or otherwise questionable, and not appropriate for reimbursement
under contract terms at that time. Such costs may be determined
reimbursable after the contractor provides the auditor additional
documentation or explanation. Disapproved costs are costs that have been
determined to be unallowable, that is, not reimbursable under the contract
terms.

17 The Defense Federal Acquisition Regulation Supplement defines a
qualifying proposal as a proposal containing sufficient information for
DOD to do complete and meaningful analyses and audits of the (1)
information in the proposal and (2) any other information the contracting
officer has determined DOD needs to review in connection with the
contract. DFARS 217.7401(c).

Corps officials told us that changing requirements made it difficult for
the contractor to submit a proposal. In particular, the requirements for
the fuel mission were not well defined and changed over time, particularly
in terms of the quantity of fuel needed and the period of performance for
the work. According to Corps officials, the fuel mission was initially
envisioned as a 21-day requirement, but ultimately extended into many
months. The extension of the requirements is reflected in modifications to
task order 5, the initial fuel mission task order, where the period of
performance was extended. Additionally, numerous correspondences between
DOD officials demonstrate the uncertainty as to how much fuel was required
and the time frame during which fuel importation would be needed. For
example, one correspondence indicates that as of April 21, 2003, there was
no immediate need for the importation of fuel products because Iraq was
able to provide sufficient refined products to satisfy the domestic need,
and one DOD official considered it unlikely that the need would arise.18
Less than 2 weeks later, on May 2, 2003, DOD correspondence indicates that
fuel shortages were anticipated, and DOD officials began preparations to
execute the fuel importation mission. At that time, officials anticipated
the need for 10- to 30-day supplies of fuel, not a mission that would
expand into many months. In addition, the statements of work for the fuel
mission did not outline the quantities needed to fulfill the mission. The
quantities of fuel required changed numerous times. For example, between
July 16, 2003, and August 3, 2003, the Corps issued four separate letters
to the contractor, each one increasing the quantities of fuel required to
fulfill the mission. Overall, through numerous modifications, the Corps
increased the funding on task order 5 from $24 million to $871 million, a
value more than 36 times greater than the initial allocation.

The Corps also experienced challenges in establishing and maintaining a
consistent, reliable, and sufficient source of funding for the RIO I
contract, which exacerbated the problem of fully defining the
requirements. The RIO I task orders were funded using several sources,
including the Army's Operation and Maintenance Appropriation, Iraqi vested
assets, and the Development Fund for Iraq.19 For the fuel mission, a
high-level Corps official involved in the funding aspect of the contract
told us that the Corps had a difficult time finding enough funding to
support the mission, a fact that contributed to short-term requirements.
For example, this official told us that the Corps received funding on a
short-term basis rather than the longer-term funding it requested, which
affected the quantity of fuel the Corps could direct the contractor to
purchase. Additionally, to support the fuel mission when funding was
tight, the Corps began using funds from the infrastructure repair and
restoration task orders to fund the fuel mission task orders, resulting in
the delay of work the Corps believed was critical to the repair of the oil
infrastructure.

18 However, DOD did recognize the need to have a contingency plan
available in case the need arose.

DOD officials and contractor representatives also told us that the
contractor's business systems were not fully prepared to handle the growth
in work the company experienced as a result of the war in Iraq, and this
contributed to the delays in proposal submission. From 2002 to 2004, the
contractor's revenues grew from $5.7 billion to $11.9 billion. Subsequent
to the issuance of the RIO I contract, and after the war in Iraq began,
DCAA identified deficiencies in several of the contractor's business
systems. For example, DCAA considered the contractor's estimating
system--a system important for proposal development--adequate prior to the
issuance of the RIO I contract. However, subsequent to the issuance of the
RIO I contract, DCAA issued an audit that found the contractor's
estimating system to be inadequate for providing verifiable, supportable,
and documented cost estimates that are acceptable for negotiating a fair
and reasonable price.20

19 "Vested assets" refers to former Iraqi regime assets held in U.S.
financial institutions that the President confiscated in March 2003 and
vested in the U.S. Treasury. The United States froze these assets shortly
before the first Gulf War. The USA PATRIOT ACT of 2001 amended the
International Emergency Economic Powers Act to empower the President to
confiscate certain property of designated entities, including these
assets, and vest ownership in an agency or individual. The President has
the authority to use the assets in the interests of the United States. In
this case, the President vested the assets in March 2003, and these funds
were made available for the reconstruction of Iraq in May 2003.

20 In its most recent audit of the contractor's estimating system, issued
in September 2005, DCAA found that the contractor had taken corrective
action and made improvements to the system. However, DCAA continued to
cite some deficiencies in the system. As of December 2004, the DOD systems
administrative contracting officer who is responsible for determining the
acceptability of the contractor's estimating system determined the system
to be acceptable with corrective action. This determination was in effect
as of the issuance of this report.

We have shown through our previous work the link between delays in
definitization and challenges with requirements, funding, and proposal
submission. For example, in a review of 77 undefinitized contract actions
issued by various DOD agencies, we found that contracting officers cited
timeliness of a qualifying proposal, changing or complex requirements, and
changes in funding availability as three of the top four reasons for
delays in definitization.21 In a previous review of Iraq reconstruction
contracts, agency officials told us that delays in reaching agreement on
the terms and conditions of a contract resulted from the growth in
requirements and from concerns over the adequacy of contractor
proposals.22

Delays in definitization can increase the risk to the government because
when contracts remain undefinitized, the government bears most of the
risk. For example, in a prior review of how DOD addressed DCAA's audit
findings on 18 audits of Iraq contract actions, we found that DOD
contracting officials were less likely to remove questioned costs from a
contract proposal if the contractor had incurred these costs before
reaching agreement on the work's scope and price.23 In a previous review
of Iraq reconstruction contracts, as well as a review of DOD's logistics
support contracts, we found that delays in definitizing contract actions
can increase the risk to the government by reducing cost control
incentives, particularly for cost reimbursement type contracts like the
RIO I contract.24

DCAA Attributes $26 Million in Cost Reductions on the RIO I Contract to Its
Audit Findings

In total, DCAA considers $26 million of the costs questioned on the RIO I
contract to be sustained. DCAA defines questioned costs sustained as the
negotiated cost reductions directly attributable to questioned cost
findings reported by the DCAA auditor. DCAA's calculation of questioned
costs sustained includes costs DOD decided not to pay to the contractor
and other types of cost reductions. Specifically, the $26 million of
questioned costs sustained includes (1) $9 million composed primarily of
costs DOD decided not to pay to the contractor and including some costs
DOD decided to pay but moved from one task order to another because of
improper allocation25 and (2) $17 million in costs removed from the
contractor's final proposals but questioned by DCAA in prior audits of
previous contractor proposals. For example, in an early version of a
proposal for one of the fuel mission task orders, the contractor proposed
demobilization costs that DCAA questioned. The contractor removed these
costs in a subsequent proposal, and DCAA considered the removal of these
costs attributable to its audit findings, and therefore counted that
amount as sustained. For purposes of calculating a sustention rate, which
is a calculation of questioned costs sustained divided by questioned
costs, in its internal management system DCAA increased its questioned
costs on the final audits from $221 million to $237 million to reflect the
$17 million sustained from prior audits.26

21 GAO, Defense Contracting: Use of Undefinitized Contract Actions
Understated and Definitization Time Frames Often Not Met, [24]GAO-07-559
(Washington D.C.: June 2007).

22 GAO, Rebuilding Iraq: Fiscal Year 2003 Contract Award Procedures and
Management Challenges, [25]GAO-04-605 (Washington D.C.: June 2004).

23 GAO, Iraq Contract Costs: DOD Consideration of Defense Contract Audit
Agency's Findings, [26]GAO-06-1132 (Washington D.C.: September 2006).

24 [27]GAO-04-605 and GAO, Military Operations: DOD's Extensive Use of
Logistics Support Contracts Requires Strengthened Oversight,
[28]GAO-04-854 (Washington D.C.: July 2004).

Table 2 shows the questioned costs sustained and the sustention rate for
each of the audits of the RIO I contract. The sustention rates ranged from
0 to 20 percent for the fuel mission task orders, which represented a
large portion of the questioned costs. As discussed earlier in the report,
the DOD contracting officer collected additional information and conducted
additional analysis to address some of these questioned costs.
Additionally, he identified limitations to the comparison between the
prices paid by the contractor and DESC used by DCAA to question some of
the fuel costs, such as differences in the length of contract terms for
purchase of fuel and fuel delivery from Kuwait, and referred to these
limitations in his rationale for his decision on these costs.

25 For example, in one audit, DCAA questioned whether some costs were
properly allocated to the task order, and suggested the costs should be
allocated to another task order under the contract. The DOD contracting
officer agreed the costs were improperly allocated, and moved the costs to
the appropriate task order. Because DCAA calculates questioned costs
sustained for each audit, DCAA considered these questioned costs
sustained.

26 Numbers do not add due to rounding. DCAA officials told us that, in
general, DCAA calculates a sustention rate across all audits for each
fiscal year. They use the sustention rates for internal management
purposes--for example, they compare the sustention rate from fiscal year
to fiscal year to see if there is variation. When there is variation, they
try to identify reasons for that variation. The officials told us they do
not have a specific goal for an overall sustention rate, and that it is
not unusual for an individual audit to have a sustention rate of 0 percent
or of 100 percent.

Table 2: DCAA's Questioned Costs Sustained on the RIO I Contract Audits

Dollars in thousands
                                             Questioned                       
                                            costs based                       
                                              on DCAA's            Sustention 
                             Primary           internal Questioned     rateby 
Task                      questioned      management      costs      audit 
order    Purpose          costs reason       systema  sustained     report 
1        Pre-positioning  Differences                                      
            and training     between                                          
                             proposed and                                     
                             actual costs          $904       $904       100% 
2        Quick fix design Differences                                      
                             between                                          
                             proposed and                                     
                             actual costs           200        197        99% 
3        Infrastructure   Costs not                                        
            repair and       allocable to                                     
            restoration      task order          20,290     12,555        62% 
4        Life support     Indirect                                         
                             costs due to                                     
                             rate and                                         
                             base                                             
                             differences             86          0         0% 
4        Equitable        Indirect                                         
            adjustment claim costs due to                                     
            - life support   rate and                                         
                             base                                             
                             differences             39         39       100% 
5        Fuel import and  Kuwait and                                       
            distribution     Turkey fuel                                      
                             and fuel                                         
                             delivery                                         
                             charges             84,446          0         0% 
6        Infrastructure   Timing of                                        
            repair and       obtaining                                        
            restoration      contracting                                      
                             officer                                          
                             consent             32,194          0         0% 
7        Fuel import and  Kuwait and                                       
            distribution     Turkey fuel                                      
                             and fuel                                         
                             delivery                                         
                             charges             35,681          0         0% 
8        Fuel import and  Kuwait and                                       
            distribution     Turkey fuel                                      
                             and fuel                                         
                             delivery                                         
                             charges             27,423      5,509        20% 
9        Fuel import and  Kuwait and                                       
            distribution     Turkey fuel                                      
                             and fuel                                         
                             delivery                                         
                             charges             22,552      4,618        20% 
10       Fuel import and  Kuwait and                                       
            distribution     Turkey fuel                                      
                             and fuel                                         
                             delivery                                         
                             charges             13,603      2,336        17% 
Contract                                                                   
total                                       $237,418    $26,158        11% 

Source: GAO analysis of DOD data.

aData in this column include costs questioned in the final audits and
costs questioned in prior audits that DCAA considers sustained.

The Sustention Rates on the DCAA Audits of the RIO I Contract and the Sustention
Rates on DCAA Audits of Other Iraq Contract Actions Both Varied Widely

We compared the sustention rates for the 11 RIO I audit reports to the
sustention rates for 100 DCAA audits of other Iraq contract actions, and
found a similar pattern in the distribution and range of sustention rates
for both groups.27 Specifically, as shown in figure 3, the sustention
rates for both groups of audit reports varied widely. DCAA officials told
us that it is not unusual to have a sustention rate of 0 percent or of 100
percent on an individual audit, and these were common values in the two
groups we looked at.

Figure 3: Comparison of Sustention Rates

Note: While this analysis provides a basis for context, the circumstances
surrounding each of the contracts or task orders audited are unique.
Consequently, sustention rates between individual audit reports may not be
directly comparable.

27 For comparison purposes, we used the audit report as our unit of
analysis. By using the audit report as the unit of analysis, each
sustention rate generally reflects a contracting officer's decision on how
to address DCAA's findings for that particular audit. As a management tool
used by DCAA, sustention rates do not represent an analysis of the
validity of underlying costs or how the contracting officer made a
decision on the reasonableness of specific costs.

DCAA officials told us that they do not expect every questioned cost to be
sustained, because reasonable people can disagree about how some of these
costs should be resolved. Additionally, as discussed earlier, contracting
officers may consider other information provided subsequent to DCAA's
issued audit as part of the process of resolving DCAA audit findings.

DOD Paid About Half of the Maximum Possible Award Fee for the RIO I Contract,
but Did Not Fully Adhere to Key Steps in Its Award Fee Plan for Providing
Performance Feedback to the Contractor

DOD paid approximately $57 million in award fees, or 52 percent of the
maximum possible award fee, for the RIO I contract. However, DOD missed
potential opportunities to motivate contractor performance by not
following steps outlined in its award fee plan to provide performance
feedback to the contractor. Further, DOD was unable to provide sufficient
documentation to enable us to fully evaluate its adherence to its award
fee plan. In comparing the RIO I award fee to award fees earned on other
selected Iraq reconstruction contracts, we found that the percentage of
award fee earned on the RIO I contract fell within the lower range of fees
earned on these other contracts.

DOD Paid Approximately $57 Million in Award Fees for the RIO I Contract

The overall award fee paid to the contractor on the RIO I contract totaled
about $57 million, just over half of the maximum possible award fee. The
contract provided for a fixed fee of 2 percent of the negotiated estimated
contract cost and an award fee of up to an additional 5 percent that could
be earned based on the government's evaluation of the contractor's
performance in areas including technical and cost performance and business
management. The possible 5 percent award fee was based on a negotiated
estimated contract cost of about $2.2 billion, translating into a maximum
award fee of about $109 million.28 The award fee decision states that,
overall, while the quality of the contractor's work was generally rated
highly, the contractor did not do as well in the areas of adherence to
schedule and business management. As shown in table 3, the award fee
varied by task order, ranging from 4 percent to 72 percent of the possible
award fee.

28 The total value of the RIO I contract was about $2.5 billion, including
the negotiated costs to be paid and the fixed and potential award fees
that could be earned by the contractor.

Table 3: Award Fee Paid for RIO I Task Orders

Dollars in thousands
                                                                Percentage of 
Task                                    Award fee Award fee possible award 
order Purpose                            possible      paid       fee paid 
1     Pre-positioning and training           $399      $175             44 
2     Quick fix design                         54        39             72 
3     Infrastructure repair and            32,333    11,640             36 
         restoration                                                          
4     Life support                          2,207       794             36 
5     Fuel import and distribution         39,208    26,662             68 
6     Infrastructure repair and             9,700       388              4 
         restoration                                                          
7     Fuel import and distribution         14,354     9,761             68 
8     Fuel import and distribution          7,679     5,222             68 
9     Fuel import and distribution          1,896     1,289             68 
10    Fuel import and distribution            802       546             68 
Contract total                           $108,631   $56,515            52% 

Source: GAO analysis of DOD data.

Note: A separate request for equitable adjustment was also negotiated for
task order 4. However, because the equitable adjustment claim exceeded the
not-to-exceed amount for task order 4, the contracting officer decided
that no fixed or award fees would be paid on the claim.

DOD Missed Opportunities to Motivate Contractor Performance by Not Following Key
Steps Outlined in Its Award Fee Plan

DOD's award fee plan for the RIO I contract included several steps related
to providing the contractor with ongoing performance feedback. For
example, the plan called for award fee evaluations to be conducted on a
regular basis during the period of performance.29 These evaluations were
to include a meeting of the award fee board to determine a recommended
award fee for the contractor and a final decision by the award fee
determining official. After each award fee evaluation, the contractor was
to be notified of the percentage and amount of award fee earned. In
addition to these formal award fee evaluations, the plan also called for
monthly interim evaluations to be conducted in which award fee board
members would consider performance evaluation reports submitted by DOD
staff designated as performance monitors, reach an interim evaluation
decision, and then notify the contractor of the strengths and weaknesses
for the evaluation period.

29 Specifically, the plan noted that end-of-period evaluations were to be
conducted semiannually for the first evaluation period and quarterly for
all remaining performance periods thereafter.

However, despite its plans to conduct formal award fee evaluations during
the period of performance, DOD did not convene an award fee board for the
RIO I contract until contract performance was almost entirely completed.
DOD officials told us that they were unable to hold boards due to the
heavy workload of RIO staff and logistical challenges such as difficulties
with communications, travel, and security conditions. DOD officials and
contractor representatives also indicated that holding an award fee board
was not a high priority because their focus was on making sure that the
work under the contract was accomplished. Ultimately only one award fee
board was held, in July 2004, after fieldwork on all but one task order
had been completed. The contractor was notified of its award fee scores in
January 2005, after completion of all work on the contract.30 This process
was in contrast to the rationale for award fee evaluations explained in
federal regulations: Evaluation at stated intervals during performance,
accompanied by partial payment of the fee generally corresponding to the
evaluation periods, can induce the contractor to improve poor performance
or to continue good performance.

In addition to not holding formal evaluations as planned during the period
of performance, DOD did not meet the rigor called for in the award fee
plan when providing interim performance feedback to the contractor. DOD
did provide some interim feedback to the contractor on its performance
during the period of performance. For example, DOD officials and
contractor representatives told us that DOD contracting staff and
contractor staff had daily informal discussions about contractor
performance. In addition, RIO administrative contracting officers sent the
contractor letters on a semiannual basis that provided feedback on the
contractor's performance. However, as discussed previously, the award fee
plan states that the award fee board should hold monthly interim
evaluations of the contractor's performance and provide the contractor
with feedback from the evaluations. DOD officials were only able to
provide us with information about one interim evaluation board, and the
contractor was not provided with results from this evaluation. Contracting
staff and others providing feedback to the contractor expressed to us
views ranging from very negative to very positive on the contractor's
performance during the same time period. Thus, without feedback reflecting
consensus judgment, the contractor may not have been fully aware of the
government's views on the strengths and weaknesses of its performance.
Given that the award fee is intended to motivate excellence in contractor
performance, providing the contractor with this type of feedback is an
important step in achieving this aim.

30 After receiving DOD's initial award fee decision in January 2005, the
contractor requested the opportunity to have its award fee scores
reconsidered. The award fee determining official granted this request.
After the contractor presented additional information, the award fee
determining official made some upward adjustments to the award fee in his
final decision when he determined that new information provided by the
contractor was sufficiently significant to do so. In this report, all
award fee amounts and percentages refer to the award fee determining
official's final decision.

The lack of adherence to the award fee plan also made it difficult to
ensure that all aspects of the contractor's performance were considered in
the final award fee decision. Although performance monitors were supposed
to complete reports monthly and at the end of each evaluation period in
order to provide the award fee board with information about the
contractor's performance, which would mean that hundreds of reports should
have been completed during the course of the contract, a DOD official told
us that fewer than 10 performance monitor reports were ever provided to
the award fee board. The board received so few reports because (1) written
reports were not prepared on a regular basis, as required by the award fee
plan, and (2) reports that were prepared were not submitted to the award
fee board. Specifically, DOD officials and correspondence indicated that
performance monitor reports did not begin to be completed until several
months into the contract period of performance and even then were not
completed on a monthly basis. In addition, DOD officials provided us with
more than 25 reports that they told us had been completed but not provided
to the award fee board members. DOD officials told us that board members
were not provided with these documents because the Corps had received a
large number of documents related to the RIO I contract from Iraq that had
not been sorted through by the time the award fee board was held in July
2004. Because the DOD officials had not sorted through all of the
documents, the award fee board was also not provided with full information
about an interim evaluation board held in May 2003. Specifically, award
fee board members were provided with only one task order score from the
interim evaluation board, despite the fact that documentation of consensus
scores and contractor strengths and weaknesses was prepared for four task
orders. DOD officials responsible for selecting the award fee board
members told us that they selected board members to ensure that they
included individuals who had directly observed the contractor in different
time periods and locations. However, because the award fee board meeting
was near the end of fieldwork on the contract and because RIO staff
rotated during the period of performance, written observations of
contractor performance would have been important in ensuring that the
board had full knowledge of all aspects of the contractor's performance.

We have previously reported on problems with DOD adhering to its award fee
process in contingency situations. In our review of DOD's use of logistics
support contracts, for one large contract we found that the Army was not
holding award fee boards according to the terms of the contract. We also
found that Army officials were not evaluating and documenting the
contractor's performance on that contract.31

DOD Could Not Provide Sufficient Documentation to Enable Us to Fully Evaluate
Its Adherence to Its Award Fee Plan

To evaluate the extent to which DOD followed its planned process for
making the RIO I award fee decision, we attempted to review DOD's
adherence to the process outlined in its award fee plan, but were not able
to fully do so because DOD could not provide us with documentation of some
elements of the process. For example, according to DOD officials and the
award fee board minutes, the board determined its recommended score for
each task order by first reaching a consensus on individual criteria
outlined in the contract, and then computing the overall score based on
the weighting included in the contract for those criteria. However,
according to DOD officials, they could not provide us with the consensus
scores on the individual criteria because records of those scores were
destroyed after the final award fee decision was reached.32 Without these
scores, we could not determine whether the award fee board adhered to the
weighting of the criteria outlined in the contract in reaching its
recommendation. We also had limited insight into any additional factors
the award fee determining official considered in making his initial
decision, which included upward adjustments to the award fee board's
recommendation, because DOD officials could not provide us with
documentation of the reasons for the difference and told us they did not
believe such documentation had ever been developed. This apparent lack of
documentation was not in accordance with the award fee plan, which states
that reasons for any differences between the award fee determining
official's decision and the award fee board's recommendation must be fully
documented.

31 [29]GAO-04-854 .

32 The Defense Federal Acquisition Regulation Supplement provided that the
basis for all award fee determinations was required to be documented in
the contract file. DFARS S 216.405-2(a)(ii) (Currently, this provision is
in DFARS Procedures, Guidance, and Information S 216.405-2(2)). However,
there is no specific requirement that records of the award fee board's
consensus scores on individual criteria be kept.

DOD officials also could not provide us with complete information
regarding the monitoring of the contractor's performance during the period
of performance. For example, we could not obtain full documentation of
interim boards referred to in the award fee board minutes, including
documentation of the number of boards held, the dates of the boards, or
the results from the boards. Without such information, we could not
determine how results from interim evaluations were figured into the award
fee board's recommendation, as the award fee plan indicates they should
be.

The Percentage of Award Fee Earned on the RIO I Contract Fell within the Range
of Award Fees Earned on a Sample of Other Iraq Reconstruction Contracts

To put the RIO I award fee into context, we also analyzed the award fees
earned on other selected Iraq reconstruction contracts and found that the
percentage of award fee earned on the RIO I contract was within the range
of award fees earned on these other contracts. More specifically, we
reviewed 11 contracts that DOD awarded in 2004 to conduct reconstruction
activities in Iraq, which, like the RIO I contract, were large-scale
cost-plus-award-fee contracts. During the period we looked at, January
2004 through June 2006, a total of 37 award fee evaluation periods were
conducted for the 11 contracts. As illustrated in figure 4, the percentage
of award fee earned during the period varied by contract, ranging from 20
percent to nearly 100 percent.

Figure 4: Percentage of Award Fee Earned on the RIO I Contract and on 11
Other Selected Iraq Reconstruction Contracts from January 2004 to June
2006

Notes: Because some of these contracts were still active as of June 2006,
the ultimate amount and percentage of award fees earned may have changed
depending on contractor performance over the remainder of the contract. In
11 of the 37 award fee evaluation periods we analyzed, the award fee
determining official chose to roll over the unearned award fee from one
evaluation period to a subsequent evaluation period or periods. In these
cases we excluded rolled-over fees from the available fee pool. While this
analysis provides a basis for context, the circumstances surrounding each
contract are unique. Consequently, the percentage of award fee earned may
not be directly comparable between contracts.

Conclusion

To meet the urgent operational needs of reestablishing Iraq's oil
infrastructure and importing fuel, the Corps authorized the contractor to
begin work before task orders had been definitized. Factors such as
changing requirements, funding challenges, and problems with contractor
proposals delayed negotiations until well past the timing required by DOD
for definitization. For all 10 RIO I task orders, the work was completed
before negotiations were finalized. Delays in definitizing contract
actions can increase the risk to the government by reducing cost control
incentives, particularly for cost reimbursement type contracts. In
addition, our findings on the agreement reached between DOD and the
contractor on the RIO I contract build on other significant evidence in
our prior work that the value of DCAA's audits of contractor proposals is
limited when negotiations take place too long after work has begun.

Award fees can serve as a valuable tool to help control program risk and
encourage excellence in contract performance. To reap the advantages that
cost-plus-award-fee contracts offer, the government must implement an
effective award fee process, which requires additional administrative
effort and cost to monitor and evaluate performance. The FAR requires that
the expected benefits of using a cost-plus-award-fee contract are
sufficient to warrant this additional effort and cost, but in the case of
the RIO I contract, even if this condition had been met, DOD's Army Corps
of Engineers did not carry out its planned award fee process. According to
DOD officials, efforts to hold award fee boards during the period of
performance were stymied in part by the logistical conditions in Iraq. We
have previously identified problems with DOD's award fee process in
contingency environments. Given that the award fee is intended to motivate
excellence in contractor performance, providing the contractor with
regular feedback that reflects the consensus of the government about its
strengths and weaknesses is important to enable the contractor to put
forth its best effort to excel in the areas deemed important to the
government. While contingency situations may pose additional challenges
for adhering to an award fee process, without an effective process, the
government risks incurring the additional cost and administrative effort
of an award fee contract without receiving the expected benefits.

Recommendation for Executive Action

To ensure that cost-plus-award-fee contracts provide the intended
benefits, we recommend that the Secretary of the Army take the following
action:

           o In contingency situations, as a part of weighing the costs and
           benefits of using a cost-plus-award-fee contract, ensure that an
           analysis of the administrative feasibility of following a rigorous
           award fee process is conducted before the contract is awarded.

Agency Comments and Our Evaluation

We provided a draft of this report to DOD for comment. In written
comments, DOD concurred with our recommendation. The department's comments
are reproduced in appendix II. In concurring with the recommendation, DOD
noted a number of factors that exist in this contingency operation that it
believed demonstrated the difficulty of conducting an analysis of the
administrative feasibility of using an award fee contract in future
contingency situations. These factors included urgent contracting time
frames, uncertain requirements, and difficulties in identifying
appropriate oversight personnel. As specified in federal regulations, the
use of an award fee contract is suitable when the expected benefits of
such a contract are sufficient to warrant the additional effort and cost
required to monitor and evaluate contractor performance. It is precisely
factors such as those outlined by DOD that we believe are important for
consideration when determining the administrative feasibility of a
cost-plus-award fee contract in a contingency environment.

As agreed with your offices, unless you publicly announce the contents of
this report earlier, we plan no further distribution until 30 days from
the report date. At that time, we will send copies to the Secretary of
Defense and other interested parties. We will make copies of this report
available on request. In addition, this report will be available at no
charge on GAO's Web site at http://www.gao.gov.

If you have any questions concerning this report, please contact me at
(202) 512-4841 or by e-mail at [email protected]. Contact points for our
Offices of Congressional Relations and Public Affairs may be found on the
last page of this report. Other major contributors to this report were
Marie Ahearn, Penny Berrier Augustine, Greg Campbell, Arthur James Jr.,
Eric Lesonsky, Stephen Lord, Anne McDonough-Hughes, Janet McKelvey, and
Kenneth Patton.

John P. Hutton
Director
Acquisition and Sourcing Management

Appendix I: Objectives, Scope, and Methodology

To determine how the Department of Defense (DOD) addressed the Defense
Contract Audit Agency's (DCAA) audit findings on the Restore Iraqi Oil
(RIO I) contract and the factors that contributed to DOD's decision of how
to address those findings, we reviewed negotiation memorandums and 22 DCAA
audit reports, including 11 final audit reports, for the 10 RIO I task
orders. Additionally, we reviewed other documents related to the
negotiation process and resolution of DCAA's findings. We also interviewed
Corps, DCAA, and other government officials as well as contractor
representatives. Because a contracting officer has the discretion to
determine whether or not to pay questioned costs when reaching agreement
with a contractor, our review does not include a determination of whether
the DOD contracting officer should have approved payment for the
questioned costs. Additionally, to put DOD's decisions of how to address
DCAA's RIO I contract audit findings into context, we compared the
resolution of DCAA's questioned cost findings on 100 audits of other
Iraq-related contract actions to the resolution of the questioned cost
findings on the RIO I task order audits. We selected the 100 audits for
comparison because they represented all audits of Iraq-related contract
actions other than the RIO I contract for which DCAA had calculated the
questioned costs sustained as of the end of fiscal year 2006, excluding
those calculated automatically.1 To ensure we used a consistent unit of
measurement, we used the audit report as the unit of analysis for
comparison. To develop an understanding and assess the reliability of the
information included in the database that contained the results for these
100 audits, we held discussions with and obtained documentation from DCAA
officials located at Fort Belvoir and we conducted electronic and manual
testing for obvious inconsistencies and completeness. We determined the
data used in our review to be sufficiently reliable for our purposes.

To determine the extent to which DOD paid award fees for the RIO I
contract and followed its planned process for making that decision, we
collected and reviewed key documents related to the award fee process,
including the award fee provisions of the RIO I contract, the award fee
determining official's decision, the award fee plan, and minutes from the
award fee board meeting. We also interviewed Corps officials, including
the award fee determining official and members of the award fee board, to
develop an understanding of the process and outcome for the award fees,
and contractor representatives to obtain their perspective on award fees.
Additionally, to put the award fee for the RIO I contract into context, we
gathered and analyzed award fee documentation provided by the Joint
Contracting Command-Iraq/Afghanistan for 11 contracts that DOD awarded in
2004 to conduct reconstruction activities in Iraq. We selected these
contracts because, like the RIO I contract, they were large-scale,
cost-plus-award-fee contracts. During the period we looked at, January
2004 through June 2006, a total of 37 award fee evaluation periods were
conducted for the 11 contracts. In 11 of the 37 award fee evaluation
periods we analyzed, the award fee determining official chose to roll over
the unearned award fee from one evaluation period to a subsequent
evaluation period or periods. In these cases we excluded rolled-over fees
from the available fee pool. Because an award fee determination is a
unilateral decision made solely at the discretion of the government based
upon judgmental evaluations of contractor performance, our review does not
include an assessment of whether DOD reached the appropriate award fee
decision for the RIO I contract.

1 According to DCAA guidance, for certain types of audit assignments with
questioned costs lower than $500,000, DCAA's internal management system
automatically calculates questioned costs sustained based on the actual
average sustention rate of proposals for an agency with questioned costs
over $500,000 for the prior 3 fiscal years. Because questioned costs
sustained is calculated automatically for these assignments, the
sustention rate does not reflect the contracting officer's decision on the
specific audit, and therefore we excluded these cases from our analysis.

We conducted our work from October 2006 through July 2007 in accordance
with generally accepted government auditing standards.

Appendix II: Comments from the Department of Defense

(120596)

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[36]www.gao.gov/cgi-bin/getrpt?GAO-07-839 .

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Highlights of [37]GAO-07-839 , a report to congressional requesters

July 2007

DEFENSE CONTRACT MANAGEMENT

DOD's Lack of Adherence to Key Contracting Principles on Iraq Oil Contract
Put Government Interests at Risk

The Department of Defense's (DOD) U.S. Army Corps of Engineers (Corps)
awarded the $2.5 billion Restore Iraqi Oil (RIO I) contract to Kellogg
Brown & Root in March 2003 in an effort to reestablish Iraq's oil
infrastructure. The contract was also used to ensure adequate fuel
supplies inside Iraq. RIO I was a cost-plus-award-fee type contract that
provided for payment of the contractor's costs, a fixed fee determined at
inception of the contract, and a potential award fee. The Defense Contract
Audit Agency (DCAA) reviewed the 10 RIO I task orders and questioned $221
million in contractor costs. We were asked to determine (1) how DOD
addressed DCAA's RIO I audit findings and what factors contributed to
DOD's decision and (2) the extent to which DOD paid award fees for RIO I
and followed the planned process for making that decision. To accomplish
this, we reviewed DOD and DCAA documents related to RIO I and interviewed
Corps, DCAA, and other officials.

[38]What GAO Recommends

GAO recommends the Secretary of the Army, in contingency situations,
ensure that an analysis of the feasibility of following a rigorous award
fee process is conducted when using cost-plus-award-fee contracts. In
written comments, DOD agreed with the recommendation.

DOD considered DCAA's audit findings on the RIO I contract and performed
additional analysis before deciding to pay the contractor nearly all of
the $221 million in costs that DCAA questioned. DOD did, however, remove
about $112 million of the questioned costs from the amount used to
establish the contractor's fee pool, which resulted in an effective
lowering of the fee received by the contractor by approximately $5.8
million. Lack of timely negotiations contributed significantly to DOD's
decision on how to address the questioned costs--all 10 task orders were
negotiated more than 180 days after the work commenced. As a result, the
contractor had incurred almost all its costs at the time of negotiations,
which influenced DOD's decision to pay nearly all of the questioned costs.
The negotiation delays were in part caused by changing requirements,
funding challenges, and inadequate contractor proposals. In our previous
work, we have found that negotiation delays can increase risk to the
government. Overall, DCAA considers $26 million of the costs questioned on
the RIO I contract to be sustained, which DCAA defines as cost reductions
attributable to its audit findings. We compared the sustention rates on
DCAA's 11 RIO I contract audits to the sustention rates for 100 DCAA
audits of other Iraq contract actions, and found that the sustention rates
varied widely for both groups.

DOD's Army Corps of Engineers paid $57 million in award fees on the RIO I
contract, or 52 percent of the maximum possible, and on individual task
orders the fee awarded ranged from 4 to 72 percent of the fee available.
While the award fee plan required regular award fee boards during the life
of the contract, DOD did not conduct a formal board until nearly all work
on the contract was complete. As a result, DOD was not able to provide the
contractor with formal award fee feedback while work was ongoing, which
federal regulations state should be done in order to motivate a contractor
to either improve poor performance or continue good performance. DOD
officials told us the workload of RIO staff members and logistical
difficulties stemming from the challenging conditions in Iraq hindered
efforts to hold evaluation boards during the period of performance. DOD
also was unable to give us enough documentation for a full assessment of
its compliance with other parts of its plan--it did not, for example,
provide the scores the award fee board assigned to the contractor on the
individual award fee criteria, so we could not see if the award fee board
had followed contract criteria and weighting in evaluating performance. We
compared the percentage of award fees earned on the RIO I contract to the
fees earned on a group of other selected Iraq reconstruction contracts and
found that the percentage of award fees earned on RIO I fell within the
lower range of fees earned on the other contracts.

References

Visible links
  23. http://www.gao.gov/cgi-bin/getrpt?GAO-06-66
  24. http://www.gao.gov/cgi-bin/getrpt?GAO-07-559
  25. http://www.gao.gov/cgi-bin/getrpt?GAO-04-605
  26. http://www.gao.gov/cgi-bin/getrpt?GAO-06-1132
  27. http://www.gao.gov/cgi-bin/getrpt?GAO-04-605
  28. http://www.gao.gov/cgi-bin/getrpt?GAO-04-854
  29. http://www.gao.gov/cgi-bin/getrpt?GAO-04-854
  30. http://www.gao.gov/
  31. http://www.gao.gov/
  32. http://www.gao.gov/fraudnet/fraudnet.htm
  33. mailto:[email protected]
  34. mailto:[email protected]
  35. mailto:[email protected]
  36. http://www.gao.gov/cgi-bin/getrpt?GAO-07-839
  37. http://www.gao.gov/cgi-bin/getrpt?GAO-07-839
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