Currency Paper Procurement: Meaningful Competition Unlikely Under Current
Conditions (Chapter Report, 08/28/98, GAO/GGD-98-181).

Pursuant to a legislative requirement, GAO provided information on the:
(1) optimum circumstances for the procurement of distinctive currency
paper; (2) effectiveness of the Bureau of Engraving and Printing's (BEP)
efforts to encourage competition in the procurement of currency paper;
(3) fairness and reasonableness of prices paid for currency paper by BEP
and the quality of the paper purchased; and (4) potential for disruption
to the U.S. currency paper supply from BEP's reliance on a single
source.

GAO noted that: (1) the optimum circumstances for the procurement of
distinctive currency paper would include an active, competitive market
for such paper, where a number of responsible sources would compete for
BEP's requirements; (2) however, these circumstances have not existed
because of the unique market for currency paper and some statutory
restrictions; (3) BEP has been aware of the need to increase competition
and has made some efforts recently to do so in areas under its control;
(4) however, BEP must procure currency paper within the current
statutory framework, which limits currency paper contracts to 4 years,
prohibits currency paper production outside of the United States, and
prohibits purchase of currency paper from foreign-owned or controlled
entities; (5) of the 20 paper manufacturers that responded to GAO's
survey, 12 said they were interested in and have the capability now, or
could be made capable in the near future, of supplying at least part of
BEP's currency paper needs if existing statutory requirements and some
of BEP's solicitation terms were changed; (6) 7 of the 12 are domestic
paper manufacturers, and 5 are located in foreign countries; (7)
although the long-term relationship between BEP and Crane & Co., Inc.
has historically resulted in quality currency paper, BEP was unable to
determine that it had obtained fair and reasonable prices for 13 of the
17 contract actions awarded from 1988 to 1997; (8) BEP sometimes
accepted prices even though it was unable to determine that they were
fair and reasonable because it had no other source for currency paper;
(9) GAO believes that BEP's assessments of the fairness and
reasonableness of Crane's proposed prices were hampered by a number of
factors, including the lack of market prices for currency paper and the
limited analyses of proposed costs and prices it performed; (10) as the
government's agent for acquiring currency paper, BEP is responsible for
ensuring that the government's supply of paper is not disrupted; (11)
although the potential for disruption in the supply of currency paper
exists, there have been no such disruptions; (12) however, for many
years, because BEP did not maintain a reserve inventory of paper to
provide for contingencies, it was more vulnerable to adverse
consequences if a disruption had occurred and was at a disadvantage in
its contract negotiations because it lacked an alternative source for
currency paper; and (13) BEP has recently been purchasing paper to build
a 3-month reserve supply and, under the Conte Amendment, could buy paper
from a foreign source if no domestic source exists.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  GGD-98-181
     TITLE:  Currency Paper Procurement: Meaningful Competition Unlikely 
             Under Current Conditions
      DATE:  08/28/98
   SUBJECT:  Currency and coinage
             Procurement practices
             Printing or duplicating
             Federal procurement
             Sole source procurement
             Buy national policy
             Competitive procurement
             Surveys

             
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Cover
================================================================ COVER


Report to Congressional Requesters

August 1998

CURRENCY PAPER PROCUREMENT -
MEANINGFUL COMPETITION UNLIKELY
UNDER CURRENT CONDITIONS

GAO/GGD-98-181

Currency Paper Procurement

(240251)


Abbreviations
=============================================================== ABBREV

  BEP - Bureau of Engraving and Printing
  CAP - Contractor Acquired Property
  DCAA - Defense Contract Audit Agency
  DOD - Department of Defense
  FAR - Federal Acquisition Regulation
  IG - Inspector General

Letter
=============================================================== LETTER


B-278747

August 28, 1998

Congressional Requesters

In response to section 9003 of the 1997 Emergency Supplemental
Appropriations Act\1 and your requests, this report addresses (1) the
optimum circumstances for the procurement of distinctive currency
paper, (2) the effectiveness of the Bureau of Engraving and
Printing's (BEP) efforts to encourage competition in the procurement
of currency paper, (3) the fairness and reasonableness of prices paid
for currency paper by BEP and the quality of the paper purchased, and
(4) the potential for disruption to the U.S.  currency paper supply
from BEP's reliance on a single source. 

This report contains matters for congressional consideration and
recommendations to the Secretary of the Treasury. 

We are sending copies of this report to the Chairman and Ranking
Minority Member of the House Committee on Banking and Financial
Services, Subcommittee on Domestic and International Monetary Policy;
the Chairman and Ranking Minority Member of the Senate Committee on
Banking, Housing, and Urban Affairs; the Director of the Office of
Management and Budget; the Secretary of the Treasury; the Director of
BEP; the Chairman, Board of Governors of the Federal Reserve System;
the Chief Executive Officer of Crane & Co.  (the current supplier of
currency paper); and other interested parties.  We will also make
copies available to others upon request. 

If you have any questions about this report, please contact me at
(202) 512-8387.  Major contributors to this report are listed in
appendix VIII. 

Bernard L.  Ungar
Director, Government Business
 Operations Issues


List of Requesters

The Honorable Ted Stevens
Chairman
The Honorable Robert Byrd
Ranking Minority Member
Committee on Appropriations
United States Senate

The Honorable Ben Nighthorse
 Campbell
Chairman
The Honorable Herb Kohl
Ranking Minority Member
Subcommittee on Treasury,
 General Government, and Civil
 Service
Committee on Appropriations
United States Senate

The Honorable Jim Kolbe
Chairman
The Honorable Steny Hoyer
Ranking Minority Member
Subcommittee on Treasury, Postal
 Service, and General Government
Committee on Appropriations
House of Representatives

The Honorable Robert Livingston
Chairman
The Honorable David Obey
Ranking Minority Member
Committee on Appropriations
House of Representatives

The Honorable Dan Burton
Chairman, Committee on Government
 Reform and Oversight
House of Representatives

The Honorable John F.  Kerry
The Honorable Edward M.  Kennedy
The Honorable Alfonse M.  D'Amato
The Honorable Lauch Faircloth
The Honorable William H.  Frist
The Honorable Ernest F.  Hollings
The Honorable Kay Bailey Hutchison
The Honorable Frank Lautenberg
The Honorable Barbara A.  Mikulski
The Honorable Fred Thompson
United States Senate

The Honorable Joseph P.  Kennedy II
The Honorable John W.  Olver
The Honorable Rosa L.  DeLauro
The Honorable John M.  McHugh
The Honorable Gerald B.  H.  Solomon
The Honorable James A.  Traficant, Jr.
House of Representatives


--------------------
\1 Public Law 105-18, 111 Stat.  158, 196 (1997). 


EXECUTIVE SUMMARY
============================================================ Chapter 0


   PURPOSE
---------------------------------------------------------- Chapter 0:1

Since 1879, the Bureau of Engraving and Printing (BEP) of the
Department of the Treasury has bought virtually all of the paper used
to print U.S.  currency from a single supplier.  Concerned about the
lack of competition in the procurement of currency paper, fairness
and reasonableness of prices paid, and possibility of disruptions to
paper supplies, Congress directed GAO, in the 1997 Emergency
Supplemental Appropriations Act, to complete a comprehensive analysis
of the "optimum circumstances for government procurement of
distinctive currency paper" and report its findings to the House and
Senate Committees on Appropriations.  GAO received three other
requests for a review of the procurement of currency paper.  To
fulfill the mandate and the requests, GAO focused on the following
objectives: 

  -- Have BEP's efforts to encourage competition for procuring
     currency paper been effective? 

  -- Have prices paid for currency paper been fair and reasonable,
     and has the quality of the paper been ensured? 

  -- Is there potential for disruption to the U.S.  currency paper
     supply from BEP's reliance on a single supplier? 


   BACKGROUND
---------------------------------------------------------- Chapter 0:2

BEP, a bureau of the Department of the Treasury, buys currency paper
from the private sector and prints the nation's currency at
production facilities in Washington, D.C., and Ft.  Worth, Texas.  In
recent years, the currency paper contract has been about $75 million
per year.  The Department of the Treasury oversees BEP's production
of currency.  BEP reports to the Secretary of the Treasury through
the U.S.  Treasurer who is consulted on policy issues affecting BEP
and serves as the national spokesperson on such issues as currency
redesign.  The U.S.  Secret Service, another Treasury bureau, works
with BEP in assessing the security of BEP's money production
facilities and works with it on currency redesign.  The Federal
Reserve sets monetary policy for the nation and obtains new currency
from BEP and distributes it to the public through depository
institutions.  In 1997, the Federal Reserve ordered 9.6 billion
currency notes of various denominations from BEP, at an estimated
production cost of $383 million. 

For the last 119 years, Crane & Co., Inc., (Crane) of Dalton,
Massachusetts, has supplied paper for U.S.  currency.  It currently
supplies the three types of cotton paper being used.  The first type,
distinctive currency paper, does not have any security thread or
watermark and is used to print all 1- and 2-dollar notes.  The second
type contains a security thread and is currently used for 5-, 10-,
and 20-dollar notes.  The third type, new currency design paper with
a watermark and security thread, was introduced in 1995 and is used
for the newly redesigned 100-, 50-, and 20-dollar notes.  The newly
redesigned 20-dollar notes are scheduled to be put into circulation
later this year.  BEP plans to use this new currency design paper for
newly redesigned 5- and 10-dollar notes next year.  In addition,
Treasury has initiated a study to project the future demand for
currency that it expects to be completed by November 30, 1998. 

The procurement of currency paper is subject to an appropriations
limitation, called the Conte Amendment, enacted in December 1987 and
set forth at 31 U.S.C.   5114 note.  In effect, the Conte Amendment
requires that distinctive paper for U.S.  currency and passport paper
be manufactured in the United States and prohibits the purchase of
currency and passport paper from a supplier owned or controlled by a
foreign entity unless the Secretary of the Treasury determines that
no domestic source exists.  The procurement of currency paper is
subject to another statutory limitation, set forth at 31 U.S.C.  
5114, which prohibits the Secretary of the Treasury from entering
into a contract in excess of 4 years for manufacturing distinctive
currency paper. 

The United States' reliance on a single source for currency paper is
not unique; most of the other G-7 nations\2 also rely on single
domestic suppliers for their banknote paper. 


--------------------
\2 The other G-7 nations are Canada, England, France, Germany, Italy,
and Japan. 


   RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3

The optimum circumstances for the procurement of distinctive currency
paper would include an active, competitive market for such paper,
where a number of responsible sources would compete for BEP's
requirements.  However, these circumstances have not existed because
of the unique market for currency paper and some statutory
restrictions.  BEP has been aware of the need to increase competition
and has made some efforts recently to do so in areas under its
control.  However, BEP must procure currency paper within the current
statutory framework, which limits currency paper contracts to 4
years, prohibits production of currency paper outside of the United
States, and prohibits purchase of currency paper from foreign-owned
or controlled entities.  Of the 20 paper manufacturers that responded
to GAO's survey, 12 said they were interested in and have the
capability now, or could be made capable in the near future, of
supplying at least part of BEP's currency paper needs if existing
statutory requirements and some of BEP's solicitation terms were
changed.  Seven of the 12 are domestic paper manufacturers, and 5 are
located in foreign countries. 

Although the long-term relationship between BEP and Crane has
historically resulted in quality currency paper, BEP was unable to
determine that it had obtained fair and reasonable prices for 13 of
the 17 contract actions awarded from 1988 to 1997.  BEP sometimes
accepted prices even though it was unable to determine that they were
fair and reasonable because it had no other source for currency
paper.  GAO believes that BEP's assessments of the fairness and
reasonableness of Crane's proposed prices were hampered by a number
of factors, including the lack of market prices for currency paper
and the limited analyses of proposed costs and prices it performed,
especially on earlier contracts in GAO's sample.  In addition,
certain BEP practices, such as understating the quantities of
currency paper needed, caused, or may have caused, the government to
pay more for currency paper than it should have. 

As the government's agent for acquiring currency paper, BEP is
responsible for ensuring that the government's supply of paper is not
disrupted.  Although the potential for disruption in the supply of
currency paper exists, there have been no such disruptions.  However,
for many years, because BEP did not maintain a reserve inventory of
paper to provide for contingencies, it was more vulnerable to adverse
consequences if a disruption had occurred and was at a disadvantage
in its contract negotiations because it lacked an alternative source
for currency paper.  BEP has recently been purchasing paper to build
a 3-month reserve supply and, under the Conte Amendment, could buy
paper from a foreign source if no domestic source exists. 


   PRINCIPAL FINDINGS
---------------------------------------------------------- Chapter 0:4


      FACTORS THAT HAVE AFFECTED
      COMPETITION
-------------------------------------------------------- Chapter 0:4.1

Obtaining competition in currency paper procurement is challenging,
partly because of the uniqueness of the currency paper, which
requires a relatively large investment in capital equipment.  In
addition, special statutory provisions govern the acquisition of
currency paper, which provide a 4-year limit to contracts for the
manufacture of currency paper, require that it be manufactured in the
United States, and prohibit the purchase of currency paper from
foreign-owned or controlled entities. 

Treasury and BEP completed studies in 1983 and 1996 to determine what
it would take to encourage competition for procuring currency paper. 
The studies identified the following elements that have affected
competition, the first three of which could be addressed in part by
BEP:  (1) the high cost of the initial capital investment to build or
retrofit a plant to produce currency paper, (2) an inadequate
start-up period to meet specified paper deliveries, (3) the absence
of a guaranteed minimum production commitment sufficient to cover the
cost of constructing and equipping a plant, and (4) the ownership and
control provision in the Conte Amendment. 

Twelve of the 20 paper manufacturers responding to GAO's survey of 30
cotton paper manufacturers who said they are capable now, or could be
in the near future, of supplying at least part of BEP's currency
paper needs also said that they would be interested in supplying
currency paper to BEP if certain conditions were met.  Nine of the 12
said that the length of currency paper contracts would have to be
more than 4 years so that they could recover the necessary capital
investment, or BEP would have to offer to finance the capital
equipment cost.  Six of the 12 said the ownership and control
provision of the Conte Amendment would have to be relaxed.  Five of
the 12 said the amount of start-up time allowed to start delivering
the paper had to be longer than BEP has provided in the past. 

BEP has recently taken steps to stimulate competition in areas under
its control.  For example, its latest solicitation provides for up to
a 4-year performance period with multiple-award scenarios that allow
offerors to submit an offer on various-sized lots.  The solicitation
also provides that BEP will consider "innovative acquisition and
financing arrangements" proposed by offerors and up to 24 months for
a start-up period, although any required start-up period is to be
deducted from the 4-year production period. 

Other agencies have used other options for promoting competition that
BEP has not been successful with, such as creating a second supplier. 
Most of the other G-7 nations rely on single domestic suppliers for
their banknote paper. 


      BEP HAS ENSURED QUALITY BUT
      HAS NOT DEMONSTRATED THAT IT
      HAS OBTAINED FAIR AND
      REASONABLE PRICES
-------------------------------------------------------- Chapter 0:4.2

BEP said that Crane has been a reliable source for currency paper and
has not missed a paper delivery in over 100 years.  Nevertheless, BEP
has had problems negotiating prices with Crane.  GAO's review of
BEP's currency paper contracts from 1988 to 1997, which included 5
contracts consisting of 17 procurement actions, showed that BEP
determined the price to be fair and reasonable for 4 actions and was
unable to determine that the prices for 5 actions were fair and
reasonable.  BEP did not reach agreement with Crane but used Crane's
interim prices on the remaining eight actions.  The interim prices
were subsequently reduced about 4 percent by an arbitrator, and Crane
returned $12.7 million to BEP.  A primary disagreement between BEP
and Crane has centered on Crane's profit rates.  Recently, BEP agreed
to higher profit levels on the premise that the supplier's investment
in capital equipment would reduce labor costs and the government
would benefit through lower prices and improved quality.  However,
BEP's procurement records did not reflect any data as to how the
prices would be lower or how the government would otherwise benefit. 

Determining the fairness and reasonableness of currency paper prices
is challenging for a number of reasons, including the lack of a
domestic market against which to compare prices and the lack of
information on currency paper prices in foreign countries.  To
determine whether prices were fair and reasonable for most of the
contracts GAO reviewed, BEP therefore relied primarily on reviewing
(1) costs questioned by government audits of Crane's price proposals
and (2) Crane's proposed profits.  The audits and analyses of
proposed profits gave BEP a basis from which to make its
determinations and to raise concerns about proposed prices and
profits.  However, BEP has not obtained audits of Crane's estimating
system, and many audits of cost proposals that were requested pointed
out problems in Crane's cost accounting system.  In addition, until
recently, BEP's analyses of Crane's proposed costs were limited in
scope; it generally did not do price analyses; and its analyses of
profit, in some cases, were incomplete. 

Unrelated to the issue of fair and reasonable prices, GAO identified
three other BEP business practices that caused or may have caused the
government to pay more for currency paper than it should have. 
First, BEP significantly understated the quantities of currency paper
it needed, which sometimes resulted in it paying a higher price than
it should have.  Second, it did not even out the quantities of paper
it ordered over time, causing inefficiencies in its contractor's
operations.  Third, BEP did not obtain royalty-free data rights for
the security thread used in its currency paper. 


      BEP IS BUILDING AN INVENTORY
      OF CURRENCY PAPER AS A
      CONTINGENCY
-------------------------------------------------------- Chapter 0:4.3

No disruption in the supply of currency paper has occurred to date. 
Nonetheless, BEP has been vulnerable to such disruptions and in a
weak negotiating position because it did not have a second source for
currency paper or have a reserve inventory of currency paper if
negotiations were to require more time than expected.  BEP continued
to buy paper from Crane when BEP's contracting officers were unable
to determine whether the prices were fair and reasonable.  Although
the Conte Amendment provides relief to BEP in that it allows BEP to
obtain currency paper from a foreign source if no domestic source
exists, BEP officials said the foreign sources would require at least
3 months to deliver currency paper.  BEP recently decided to change
its "just-in-time" approach to one of maintaining an inventory with a
3-month supply of all three types of currency paper.  As of May 1998,
BEP officials reported that it has achieved its inventory goals with
the exception of the currency paper required for the newly redesigned
20-dollar note, which BEP expects to reach during calendar year 1999. 


   RECOMMENDATIONS TO THE
   SECRETARY OF THE TREASURY
---------------------------------------------------------- Chapter 0:5

To strengthen BEP's capacity to ensure fair and reasonable prices,
GAO recommends that the Secretary direct that BEP improve its
procurement practices in the areas of oversight and audit of the
contractor's cost accounting and estimating systems, improved
analysis and documentation of the basis for acceptance of prices and
profits, and post-award auditing.  In addition, GAO recommends that
the Secretary ensure that in all future currency paper procurements,
solicitations more accurately reflect the expected amounts of paper
needed and orders are placed for paper quantities that permit
supplier(s) to maintain a steady production level and minimize the
equipment they have to acquire. 


   MATTERS FOR CONGRESSIONAL
   CONSIDERATION
---------------------------------------------------------- Chapter 0:6

To assist the Secretary in obtaining competition from domestic
sources, Congress may wish to consider lengthening the 4-year limit
for currency paper contracts to give potential offerors a longer time
to recover their capital investments.  If adequate price competition
among two or more suppliers can be achieved, concerns over whether
the prices paid are fair and reasonable should be reduced. 

Finally, because BEP's past efforts to encourage domestic competition
for currency paper have been unsuccessful and future efforts are
uncertain, and because BEP has been unable to determine that it
obtained fair and reasonable prices from the current supplier in some
past procurements, GAO has concluded that BEP may need additional
authority to protect the government's interests in obtaining currency
paper.  Specifically, GAO concluded that Congress may want to
consider revising the Conte Amendment, which allows the Secretary of
the Treasury to obtain currency paper from a foreign-owned source
only if no domestic supplier is available, to permit the Secretary to
obtain currency paper from a foreign-owned source on a temporary
basis if it is determined that no domestic supplier will provide
paper at fair and reasonable prices.  Such a provision should improve
the likelihood that fair and reasonable prices could be obtained. 


   AGENCY AND CONTRACTOR COMMENTS
---------------------------------------------------------- Chapter 0:7

GAO provided copies of a draft of this report to the Chairman, Board
of Governors of the Federal Reserve System; BEP; the Department of
the Treasury; and Crane for comment.  GAO received written comments
from BEP that included input from Treasury (see app.  VI), written
comments from Crane (see app.  VII), and oral comments from the
Federal Reserve.  BEP and Crane also provided technical comments,
which are incorporated in appropriate sections throughout the report. 
GAO's summary of agency and Crane's comments and GAO responses are
included at the end of chapter 5, and GAO's detailed responses to
Crane's comments are in appendix VII. 

The Federal Reserve said GAO's analysis and recommendations were
reasonable.  BEP emphasized its compliance with the Federal
Acquisition Regulation in the award of the five contracts GAO
reviewed and generally disagreed with GAO's proposed recommendations
or said action had already been initiated.  Crane said GAO's proposed
recommendations to BEP to encourage competition have already been
adopted and no further action was necessary.  Crane agreed that the
4-year limit on currency paper contracts could be lengthened but
disagreed that consideration be given to revising the Conte
Amendment.  Crane also said its prices were fair and reasonable. 

GAO considered BEP's and Crane's views, made some modifications to
reflect these views, but believes that additional congressional
action to encourage competition and additional congressional and
Treasury actions to ensure prices are fair and reasonable are
appropriate.  GAO's review did not focus on compliance issues. 
Although GAO did not determine whether prices were fair and
reasonable because this is BEP's responsibility, GAO noted that BEP's
contracting officers were unable to make this determination in 13 of
17 contracting actions GAO reviewed, primarily because BEP considered
Crane's profits high. 


INTRODUCTION
============================================================ Chapter 1

Concerns about the procurement of currency paper resulted in Congress
including in the 1997 Emergency Supplemental Appropriations Act a
requirement that we complete a comprehensive analysis of the "optimum
circumstances for government procurement of distinctive currency
paper" and report our findings to the House and Senate Committees on
Appropriations.  In the conference report accompanying the
appropriations bill,\3 the Conference Committee expressed concern
over the fact that the Bureau of Engraving and Printing (BEP) of the
Department of the Treasury has bought virtually all of its paper for
the nation's currency from a single supplier for over 100 years.  The
Conference Committee directed that we report on any limitations on
competition in currency paper procurement and possible alternatives
to the way BEP has been buying the paper, the fairness and
reasonableness of prices paid for the paper, the potential for
disruption of the availability of currency paper from BEP's reliance
on a single supplier, and other matters. 

In June 1997, the Chairman of the House Government Reform and
Oversight Committee asked that we also report our findings to that
Committee because of its interest in federal procurement matters, and
Senator Lautenberg requested that we report our findings to his
office as well.  In September 1997, 16 members of Congress informed
us of their interest in our analysis and expressed their opinion that
a review of the potential benefits and drawbacks of a single-supplier
relationship would be appropriate. 


--------------------
\3 H.R.  Report No.  105-119, 105th Cong., 1st Sess., at 108-110
(1997). 


      SEVERAL AGENCIES ARE
      INVOLVED WITH THE
      ACQUISITION OF CURRENCY
      PAPER
-------------------------------------------------------- Chapter 1:0.1

BEP buys currency paper from the private sector.  It then prints the
nation's currency at production facilities in Washington, D.C., and
Ft.  Worth, Texas.  In recent years, currency paper purchases have
been about $75 million per year.  Before 1861, state-chartered
private banks issued paper money, and the federal government produced
only coins.  Partly because of the need to finance the Civil War and
a shortage of coins, Congress authorized the Secretary of the
Treasury to have notes engraved and printed by private bank note
companies in 1862.  The actual printing of currency notes by Treasury
employees began in 1863.  In 1869, Congress authorized BEP to produce
currency notes. 

The U.S.  Secret Service, another Treasury bureau created in 1865, is
also involved in currency paper matters.  The mission of the Secret
Service includes protecting the President and Vice President, their
families, and visiting foreign dignitaries; and enforcing laws
relating to U.S.  money and securities, as well as those relating to
electronic funds transfer and credit card fraud.  The Secret Service
works with BEP in assessing the security of the BEP's money
production facilities and works with it on currency redesign. 

The Department of the Treasury performs four basic functions: 
formulating and recommending national economic, financial, tax, and
fiscal policies; serving as a financial agent for the U.S. 
government; enforcing laws under the jurisdiction of Treasury
bureaus; and overseeing the production of coins and currency.  BEP
reports to the Secretary of the Treasury through the U.S.  Treasurer
and the Assistant Treasury Secretary for Management and Chief
Financial Officer.  Among other responsibilities, the U.S.  Treasurer
is consulted on policy issues affecting BEP, is a member of
Treasury's Advanced Counterfeit Deterrence Committee, and serves as a
spokesperson to the public for BEP on issues such as currency
redesign. 

In addition to Treasury, the Federal Reserve is involved in currency
paper matters.  The Federal Reserve sets monetary policy for the
nation and obtains new currency from BEP and distributes it to the
public through depository institutions.  The Federal Reserve banks
also identify counterfeit currency and destroy currency that is unfit
for circulation.  In 1997, the Federal Reserve ordered 9.6 billion
currency notes of various denominations from BEP at an estimated
production cost of $383 million (which includes the $75 million
currency paper cost). 


      BEP HAS RELIED PRIMARILY ON
      A SINGLE SUPPLIER FOR OVER
      100 YEARS
-------------------------------------------------------- Chapter 1:0.2

According to BEP officials, virtually all of the paper used in
currency has been bought from a single supplier, Crane & Co., of
Dalton, Massachusetts, since 1879.  According to a 1983 Treasury/BEP
study on currency paper procurement, during the 1960s, BEP attempted
to develop a second source of paper by contracting with Gilbert Paper
in Wisconsin for about 3 percent of its annual requirements.  This
supplier declined to submit an offer on subsequent procurements of
currency paper because its prices for a portion of the BEP's needs
were not competitive with Crane's prices for the entire BEP currency
paper requirement.  The study also stated that BEP endeavored again
in 1982 to encourage competition when it issued a solicitation that
would have split the paper requirement among two or more suppliers. 
This effort also failed because Crane offered a substantially lower
price, according to the study. 

In the early 1980s, a British paper manufacturer, Portals, Ltd.,
sought to sell currency paper to BEP and built a manufacturing plant
in Hawkinsville, Georgia.  However, the plant closed several years
after it was built without receiving any paper contracts from BEP. 

In 1991 and again in 1995, BEP entered into developmental contracts
with another firm, Crown Vantage Paper Co.  (formerly the
Communications Paper Division of the James River Paper Company),
which had a paper mill in New Jersey, to develop currency paper with
an advanced counterfeit deterrence device.  However, these efforts
did not lead to another currency paper source because (1) BEP
discontinued using the paper that Crown was developing; and (2) Crown
had problems in meeting BEP's fold endurance specifications and
needed technology that was available only from foreign sources to be
able to meet requirements of the current solicitation, according to
BEP officials. 

The Treasury Department and BEP studied the currency paper market in
1983 and in 1996 in an effort to increase competition.  These studies
identified a limited number of firms capable of producing the
cotton/linen fiber paper (also called "rag" paper).  Treasury/BEP
reported that the rag paper industry is an old and stable industry,
characterized by 15 independent paper mills producing about 90
percent of the domestic rag paper capacity.  In addition to the
domestic producers, Treasury/BEP identified a number of foreign
suppliers.  Treasury/BEP identified a number of firms, both domestic
and foreign, capable of producing currency paper, some of whom might
be interested in furnishing all or part of BEP's needs.  For security
reasons, Treasury/BEP and the Secret Service thought purchasing
currency paper produced offshore would be problematic.  Treasury/BEP
also identified foreign firms interested in joint venturing with
domestic firms to supply currency paper from locations in the United
States but concluded that the capital investment required would be
too costly for this to be successful.  The firms interviewed by
Treasury/BEP indicated that significant BEP subsidies for capital
investment, long-term production guarantees, and economic price
redeterminations in contracts would be crucial to any decision to
build or retrofit a currency paper plant in the United States. 

The 1996 Treasury/BEP report concluded that rather than invest in
developing alternative source(s) of currency paper, it would be less
costly to work with the long-standing single supplier of paper. 
However, the report also concluded that BEP should continue to
explore the marketplace through competitive solicitations to
determine if there were viable alternative sources.  The 1996 study
also reported that a number of other countries, such as England and
Germany, used single domestic sources to provide paper for the
nations' banknotes. 


      APPLICABLE LAWS
-------------------------------------------------------- Chapter 1:0.3

Title III of the Federal Property and Administrative Services Act of
1949 (Property Act), as amended,\4 as implemented by the Federal
Acquisition Regulation (FAR),\5

generally governs BEP acquisitions.  As expressed in FAR, part 15,
when contracting in a competitive environment, agencies are to obtain
supplies or services from responsible sources at fair and reasonable
prices that result in the best value to the government.  To
accomplish this, agencies are directed to use competitive procedures
to obtain full and open competition in most acquisitions above
$100,000.  The Property Act provides for several exceptions to full
and open competition, one of which may be used when supplies or
services are available from only one responsible source and no other
supplier can satisfy the agency requirement.  Alternatively, an
agency may exclude a particular source from a contract action to
establish or maintain an alternative source of supply.  Such an
exclusion may be based on a determination that to do so would
increase competition in the longer term and reduce overall cost or
would ensure the continuous availability of a reliable source. 

When competitive procedures are used and a market consisting of a
number of responsible sources for the government's needs exists, the
expected result would be adequate price competition so that an agency
would be likely to obtain supplies at a fair and reasonable price. 
For negotiated contracts, the agency must evaluate the reasonableness
of the prices submitted.  When there is adequate price competition
the agency should use price analysis.  Generally, when there is not
adequate price competition, both price and cost analyses are to be
used.\6 If a contractor insists on a price or demands a profit that
the agency's contracting officer considers unreasonable during
contract negotiations, the contracting officer is to refer the
contract action to a level above the contracting officer for
disposition.  This determination may include consideration of the
feasibility of developing an alternative source.  In making the
determination, factors such as ensuring the continuous availability
of a reliable source of supplies may outweigh cost considerations. 
If cost is the major consideration, one of the difficult questions is
to what extent the agency can expect competition to reduce the cost
of supplies. 

The procurement of currency paper is subject to an appropriations
restriction, called the Conte Amendment, enacted in December 1987 and
set forth at 31 U.S.C.   5114 note.  In effect, the Conte Amendment
requires that U.S.  currency and passport paper be manufactured in
the United States and prohibits the purchase of currency and passport
paper from a supplier owned or controlled by a foreign entity unless
the Secretary of the Treasury determines that no domestic source
exists.  According to the Conference Report accompanying the Conte
Amendment, the requirement was to enhance the security capabilities
of U.S.  law enforcement agencies.\7

The procurement of currency paper is subject to another statutory
requirement, set forth at 31 U.S.C.   5114, which prohibits the
Secretary of the Treasury from entering into a contract in excess of
4 years for manufacturing distinctive currency paper.  Although this
provision restricts the length of contracts, according to BEP, the
provision originated in 1916 and was enacted to increase the previous
1-year limitation on Treasury contracts to improve the United States'
ability to purchase linen and ink pigments from European sources in
the event war broke out. 


--------------------
\4 41 U.S.C.   251-266. 

\5 FAR implements the procurement statutes and provides uniform
policies and procedures for acquisitions by all executive agencies. 

\6 See chapter 3 for an explanation of the differences between cost
and price analysis. 

\7 H.R.  Report No.  100-498, 100th Cong., 1st Sess., at 1177-1178
(1987). 


      THREE TYPES OF PAPER ARE
      USED FOR U.S.  CURRENCY
-------------------------------------------------------- Chapter 1:0.4

BEP currently uses three types of paper for U.S.  currency. 
Distinctive currency paper is used to print all 1- and 2- dollar
notes.  This paper, which does not have any security thread or
watermark, was used to print all currency denominations before
1991.\8 A second type of paper is called distinctive currency paper
with security thread.  This paper was first bought in production
quantities in 1991 and was originally used for all denominations
above the 2-dollar note; but it is now used only for 5-, 10-, and
20-dollar notes.  The third type of paper, called new currency design
paper with a watermark and security thread, was introduced in 1995
and is being used to print the redesigned 100- and 50-dollar notes
that are currently in circulation and the newly redesigned 20-dollar
note that is scheduled to be introduced into circulation in the fall
of 1998.  BEP plans to use this paper for newly redesigned 5- and
10-dollar notes next year. 

Until recently, the manufacturing and purchasing of currency paper
was relatively simple because only one type of paper was used to
print all U.S.  currency.  Common paper manufacturing equipment was
used in the process.  BEP annually contracted for estimated
quantities of paper needed and subsequently ordered it to print the
Federal Reserve's currency requirements.  Federal Reserve currency
needs, in turn, were driven by the requirement to replace soiled
currency removed from circulation and provide for increased currency
demands. 

The threaded currency paper and the threaded currency paper with a
watermark were developed as anticounterfeit deterrents.  According to
the Secret Service, counterfeiting is becoming more of a problem as
electronic technologies advance and become available to the public. 
In the past, counterfeiters had to have access to a printing press to
counterfeit money.  Today, counterfeiters use color copiers, digital
scanners, personal computers, and ink jet color printers to replicate
money.  As a result, counterfeiters need less skill than before and
have more access to machinery capable of counterfeiting, and the cost
to counterfeit is much less.  For example, the Secret Service said
that in fiscal year 1995, the Federal Reserve discovered $32 million
in counterfeit currency that was passed on to the public, of which
0.5 percent was made with computer equipment.  In fiscal year 1998,
the Secret Service expects that $45 million to $50 million of
counterfeit currency will be passed, and 40 percent of it is expected
to have been made with the use of computer technologies. 

Using more sophisticated paper is one method of making our currency
more difficult to counterfeit.  Other nations and BEP are also
considering other materials, such as plastic, on which to print
currency to increase its durability and anticounterfeiting features. 

Throughout the world, currency paper is produced using two processes,
fourdrinier and cylinder mold.  In both processes, cotton fibers and
other materials are mixed into a pulp with water and formed into a
slurry, which is spread on a wire mesh where the water content is
greatly reduced, and formed into paper.  In the fourdrinier process,
which is used by Crane for all BEP currency and is also used for the
vast majority of all types of paper produced, including newsprint,
the slurry is sprayed onto a large horizontal wire cloth.  As the
slurry moves along horizontally, water is drained through the wire
cloth, and the fibers bind together into a sheet formation.  In the
cylinder mold process, used for many European and other nations'
banknotes, a fine wire cloth is stretched around a cylinder, which
serves as a strainer and rotates within a vat containing the pulp and
water.  As the cylinder is rotated, water is removed from the inside
of the cylinder and a layer of fibers is formed on the outside. 


--------------------
\8 Security thread is a thin, clear, polyester strip placed in the
paper during its manufacture.  The thread contains an identifiable
printed pattern and is not observable in reflected light, but it is
observable in transmitted light and cannot be reproduced by copiers. 
Watermarks are images of the portrait on the currency paper and are
made when the paper is formed by varying the density of the paper. 
The watermark is visible in transmitted light.  Both security threads
and watermarks are examples of anticounterfeiting features and are
difficult for counterfeiters to reproduce. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
---------------------------------------------------------- Chapter 1:1

The overall objective of our review as stated in the 1997 Emergency
Supplemental Appropriations Act was to analyze the "optimum
circumstances for government procurement of distinctive currency
paper." However, because that objective was broad and numerous
congressional parties were interested in this review, we met with the
interested Members' and committees' offices to determine the specific
issues they wanted addressed as well as approaches to address those
issues.  Although we identified a number of concerns and issues, they
are all covered under the following three objectives: 

  -- Have BEP's efforts to encourage competition for procuring
     currency paper been effective? 

  -- Have prices paid for currency paper been fair and reasonable and
     has the quality of the paper been ensured? 

  -- Is there potential for disruption to the U.S.  currency paper
     supply from BEP's reliance on a single supplier? 

To address these objectives, we reviewed federal procurement statutes
and regulations and specific laws related to currency paper.  We
reviewed various indicators of the competitiveness of the currency
paper market, such as the number of paper manufacturers who said they
were capable of supplying currency paper to BEP, and the factors that
make it difficult for them to provide currency paper.  We also
reviewed BEP studies of the currency paper market and obtained
information from other federal agencies, such as the Secret Service
and the Department of Defense (DOD). 

To address the first two objectives, we reviewed BEP's currency paper
procurement files for paper contracts in effect from 1988 to 1997,
analyzed how BEP bought currency paper during this period, and
compared certain BEP actions with requirements in the FAR and
applicable laws.  We surveyed 30 domestic and foreign cotton paper
manufacturers on their interests in supplying currency paper and
factors that prevented them from competing for BEP currency paper
contracts, and we surveyed other G-7 nations on how they procured
banknote paper.  We interviewed numerous officials of BEP, Treasury,
the Secret Service, the Federal Reserve, Crane, and other agencies. 
We also interviewed several of the domestic and foreign cotton paper
manufacturers that were included in our survey. 

To help us analyze the fairness and reasonableness of prices paid by
BEP for currency paper, we analyzed how BEP used audits of the single
supplier's costs and proposals in its negotiations and evaluated
whether BEP had an appropriate basis for determining the fairness and
reasonableness of prices it paid for currency paper over the last 10
years.  We toured paper mills of two cotton paper manufacturers, as
well as BEP printing facilities in Washington, D.C., and Ft.  Worth,
TX, to observe how paper was produced and currency was printed. 

To address the third objective, we interviewed officials at BEP, the
Federal Reserve, and Crane; reviewed BEP's contingency plan for
critical materials; and asked other G-7 nations what type of
contingency reserves of banknote paper they maintained. 

We did our work in accordance with generally accepted government
auditing standards from July 1997 to August 1998.  We requested
comments on a draft of this report from the Chairman, Board of
Governors of the Federal Reserve System; the Secretary of the
Treasury; and the Chief Executive Officer of Crane.  We received
written comments from BEP's Acting Director that incorporated
comments from the Treasury Department, written comments from Crane,
and oral comments from the Federal Reserve.  BEP's and Crane's
comments are reprinted in appendixes VI and VII, respectively.  Our
summary of agency and Crane's comments and GAO's responses are
discussed at the end of chapter 5.  BEP and Crane also provided
technical comments, which have been incorporated as appropriate in
the report.  A more detailed discussion of our objectives, scope, and
methodology is contained in appendix I. 


SEVERAL FACTORS RESULTED IN
LIMITED COMPETITION
============================================================ Chapter 2

The optimum circumstances for the procurement of distinctive currency
paper would include an active, competitive market for such paper
where a number of responsible sources would compete for BEP's
requirements.  However, this is currently not the case because of the
unique market for currency paper and some statutory restrictions. 
After over 100 years of relying on a single source, Treasury and BEP
completed studies in 1983 and 1996 on what it would take to encourage
competition for procuring currency paper, and BEP recently took steps
to encourage competition in matters under its control.  However,
several paper manufacturers told us that they would compete for BEP
paper contracts if additional changes were made, such as allowing
foreign-owned companies to compete to supply currency paper and
extending the length of contracts to more than 4 years.  These
changes would require existing statutory limitations to be amended. 
There are also other options for obtaining competition that are
allowed under procurement laws and have been used by other federal
agencies. 


   COMPETITION IS THE OPTIMUM
   CIRCUMSTANCE FOR THE
   PROCUREMENT OF CURRENCY PAPER
---------------------------------------------------------- Chapter 2:1

When the government purchases common commercially available goods and
services, obtaining competition is relatively easy.  However, when
the government purchases goods that serve only the government's
needs, competition is less likely to occur.  In currency paper
procurements, obtaining competition is challenging, partly because
there are few cotton paper manufacturers, currency paper is unique to
the governments' needs, and a large investment in capital equipment
is required. 


   BEP HAS IDENTIFIED FACTORS
   INHIBITING COMPETITION
---------------------------------------------------------- Chapter 2:2

Factors that inhibited competition were identified in the 1996
Treasury/BEP currency paper study.  These factors include (1) the
cost of the initial capital investment to build or retrofit a plant
to produce currency paper; (2) the short start-up period required to
comply with specified paper deliveries; (3) the risks and
uncertainties inherent in entering a limited, government-controlled
market; and (4) the restriction on acquiring distinctive currency
paper from foreign-owned or controlled companies contained in the
Conte Amendment.  Potential suppliers told BEP that it would take
between $20 million and $150 million to build or retrofit the
necessary plant and equipment to provide currency paper to BEP; and
that because of the risks inherent in entering a limited,
government-controlled market, some form of financial assistance from
BEP would be necessary.  The 1996 study also cited delivery
requirements, usually requiring delivery starting at or shortly after
contract award, as a significant inhibitor, given that manufacturers
said it takes 1 to 2 years to become operational. 

The 1996 Treasury/BEP study also found that the absence of a
guaranteed minimum production commitment sufficient to cover the cost
of constructing and equipping a plant was an inhibitor.  Potential
suppliers told Treasury/BEP they would require a long-term commitment
to manufacture a minimum of 40 percent of BEP's requirements in order
to begin production.  According to BEP, Treasury currently has a
study under way aimed at projecting the future demand for currency. 
The study is being done by representatives from Treasury, BEP, the
Mint, and the Federal Reserve.  The study is expected to be done by
November 30, 1998. 


   BEP DID NOT OBTAIN COMPETITION
   FOR CURRENCY PAPER CONTRACTS
   AWARDED FROM 1988 TO 1997
---------------------------------------------------------- Chapter 2:3

BEP awarded five separate contracts to Crane for currency paper from
1988 to 1997.  Two of these contracts, 95-23 and 97-10, were awarded
to Crane on a sole-source basis.  The other three contracts, 88-205,
91-18, and 93-14, were also awarded to Crane because BEP did not
receive any other offers in response to its solicitations. 
Additionally, in accordance with the Conte Amendment, BEP was
precluded from awarding a currency paper contract to foreign-owned or
controlled firms.  Although some matters affecting competition in the
currency paper market are beyond BEP's control, BEP's solicitations
for currency paper before 1997 did not attempt to encourage
competition by using means within its control.  As shown in table
2.1, some of BEP's solicitations contained a 1 or 2 year production
period and required potential suppliers to start providing currency
paper shortly after contract award.  Although offerors can always
request that financial assistance be provided, BEP did not offer to
provide potential offerors financial assistance for capital equipment
in its solicitations. 



                                    Table 2.1
                     
                       Selected Terms of BEP Currency Paper
                     Contracts/Solicitations for 1988 to 1997

                                 Contracts/solicitations
          ----------------------------------------------------------------------
Terms of
solicita
tion      88-205      91-18       93-14       95-23       97-10       97-13\a
--------  ----------  ----------  ----------  ----------  ----------  ----------
Length    2 years     1 year      1 year      1 year      2 years     4 years
of        with two    with three  with four   with two
contract  1-year      1-year      1-year      6-month
          options     options     options     options

Amount    None        None        None        30 days     30-60 days  Up to 24
of                                                                    months
start-
up time
provided

Sole      CS          CS          CS          Sole        Sole        CS
source                                        Source      Source
or
Competit
ive
Solicita
tion
(CS)


Financia  None        None        None        None        None        Proposals
l         offered     offered     offered     offered     offered     invited\b
assistan
ce
--------------------------------------------------------------------------------
\a This is a solicitation for which BEP plans to award a contract in
December 1998. 

\b The solicitation contained a statement that offerors would be free
to propose "innovative acquisition and financing arrangements."

Source:  BEP 1988 to 1997 currency paper procurement files. 

In 1997, BEP made significant changes to its solicitation for
currency paper.  Solicitation 97-13, issued in May 1997, provided for
up to a 4-year contract with multiple award scenarios that allowed
competitors to submit an offer on various-sized lots and it also
provided up to 24 months for a start-up period, under certain award
scenarios.  Because of BEP's concerns about violating the 4-year
limit on contracts for manufacturing currency paper, the solicitation
provided that any required start-up period would be deducted from the
4-year production period.  In addition, solicitation 97-13 also
provided that BEP will consider "innovative acquisition and financing
arrangements" proposed by offerors. 


   PAPER MANUFACTURERS REPORT THAT
   COMPETITION CONTINUES TO BE
   INHIBITED
---------------------------------------------------------- Chapter 2:4

Although BEP has taken actions to encourage competition in
solicitation 97-13, such as providing for a longer contract
performance period than in past solicitations and allowing a 24-month
start-up time, some paper manufacturers responding to our survey told
us there were other matters that prevented them from competing for
the currency paper contract.  Some manufacturers said they need an
even longer guaranteed contract period, or financial assistance
provided by the government, to recover the capital investment
required to purchase the equipment to produce the paper.  Several
paper manufacturers also would like to be able to enter into joint
ventures with a foreign paper manufacturer to produce currency paper,
but they are unable to do so because of the Conte Amendment, as
interpreted by Treasury.\9

Twelve of the 20 paper manufacturers responding to our survey of 30
worldwide firms said that they would be interested in supplying
currency paper to BEP and are capable now, or would be in the near
future, of supplying at least part of BEP's currency paper needs, but
several matters prevent them from competing.  Some of these matters
are the same as those identified in BEP's 1996 currency paper study. 
None of the 12 interested paper manufacturers said that the size of
the currency paper market would make it difficult for them to
compete.  Table 2.2 summarizes the factors inhibiting competition
reported by the 12 paper manufacturers that said they would be
interested in supplying currency paper to BEP. 



                               Table 2.2
                
                Factors Affecting Competition Identified
                by 12 Paper Manufacturers Interested in
                             BEP Contracts

                                                       Number of paper
Factors affecting competition                 manufacturers responding
----------------------------------------  ----------------------------
The length of BEP manufacturing                                      9
 contracts is too short to recover
 necessary capital investments.
The requirement that joint ventures with                             6
 foreign firms must be 90 percent U.S.
 owned or controlled.
Lack of financial assistance by BEP for                              6
 capital investment.
BEP's allowed start-up time is too                                   5
 short.
Security requirements for the                                        3
 manufacturing process.
The technology required to incorporate                               3
 anticounterfeiting features in currency
 paper.
License or royalty payments to holder(s)                             3
 of anticounterfeiting features.
----------------------------------------------------------------------
Source:  1997 GAO survey of cotton paper manufacturers. 


--------------------
\9 As discussed later in this chapter, Treasury interprets the Conte
Amendment as precluding it from entering into any contracts for
currency paper production with any entity that is more than 10
percent foreign-owned or controlled. 


         LENGTH OF CURRENCY PAPER
         CONTRACTS
------------------------------------------------------ Chapter 2:4.0.1

Nine of the 12 interested manufacturers said the performance period
in BEP's currency paper contracts has been too short to recover the
necessary capital investment.  One paper manufacturer said that it is
not possible to recover start-up costs in less than 5 years.  A
second domestic paper manufacturer told us the major reason it did
not submit a proposal was that the contract period was too short to
recover capital investment, and it believed it was unlikely that this
situation could be improved.  As a result, this paper manufacturer
decided that continuing its investment in product development was too
risky and decided not to submit a proposal. 

According to another domestic paper manufacturer, the amount of
capital investment necessary to meet BEP's requirements cannot be
recovered through the price of paper sold to BEP over a 2- to 4-year
contract.  This paper manufacturer told us that if BEP extends the
length of the currency paper contract to at least 10 years it would
consider submitting an offer. 

BEP's currency paper contracts have generally been for 1 to 2 years
with three 1-year options, with the exception of the current
solicitation 97-13, which has a performance period of up to 4 years. 
By law, the contract term to purchase U.S.  currency paper cannot
exceed 4 years.  Additionally, U.S.  money order paper contracts are
for 5 years; and U.S.  passport paper contracts are for 3 base years,
with two 1-year options.  Both passport and money order paper have
security features (i.e., watermarks and security thread) similar to
those of currency paper. 


         CONTE AMENDMENT AFFECTS
         COMPETITION
------------------------------------------------------ Chapter 2:4.0.2

The Conte Amendment provides that: 

     "None of the funds made available by this or any other Act with
     respect to any fiscal year may be used to make a contract for
     manufacture of distinctive paper for United States currency and
     securities pursuant to section 5114 of title 31, U.S.C., with
     any corporation or other entity owned or controlled by persons
     not citizens of the United States, or for the manufacture of
     such distinctive paper outside the United States or its
     possessions.  This subsection shall not apply if the Secretary
     of the Treasury determines that no domestic manufacturer of
     distinctive paper for United States currency or securities
     exists with which to make a contract and if the Secretary of the
     Treasury publishes in the Federal Register a written finding
     stating the basis for the determination."\10

Although the Conte Amendment itself does not specify ownership and
control requirements, the accompanying Conference Report states that
BEP may not enter into such a contract with an entity if 10 percent
or more of the entity is owned or controlled by a group of foreign
persons.  In 1995, the report of the House Appropriations
Committee\11 that accompanied the Treasury, Postal Service, and
General Government Appropriations Act for fiscal year 1996 attempted
to redefine the intended meaning of the Conte Amendment.  The report
stated that a domestic corporation or other entity is one "created
under the laws of the United States or any one of its states or
possessions, and .  .  .  more than 50 percent of [which] is held by
United States citizen(s)." Treasury's Office of General Counsel
concluded in a March 1997 legal opinion that the 1995 House
Appropriations Committee Report language cannot modify the
constraints established in the Conte Amendment and the
contemporaneous explanation of the provision in the 1987 conference
report. 

As part of our review, the House Appropriations Subcommittee on
Treasury, Postal Service, and General Government asked us to review
Treasury's position that the Conte Amendment precludes BEP from
entering into a contract for the manufacture of distinctive currency
paper with an entity of which 10 percent or more is owned or
controlled by a foreign company.  Because the language designating a
10-percent limitation on foreign ownership or control is in the 1987
conference report and is not specified in the statute itself,
Treasury's interpretation is not mandated by the statute. 
Nevertheless, in the absence of language in the statute defining what
constitutes foreign ownership and control, it is reasonable for
Treasury to rely on the 1987 conference report as guidance for
interpreting and applying the statutory language.  Thus, we believe
that Treasury's interpretation of the restriction in the Conte
Amendment is within its discretion. 

Six of the 12 paper manufacturers we surveyed that were interested in
supplying currency paper stated that their decisions not to respond
to BEP solicitations had been influenced by the Conte Amendment
restriction on foreign ownership.  Three of the five foreign paper
manufacturers saw this as an issue.  According to one domestic
manufacturer, the need to have 90-percent U.S.  ownership limits a
foreign entity from participating in a fashion that gives it any kind
of financial incentive.  One foreign manufacturer commented that as a
foreign paper company, it would want a larger participation than the
10 percent currently allowed.  Similarly, two domestic paper
manufacturers commented to BEP in 1995 that the restriction on
foreign ownership limited their capability to gain access to the only
source of currency paper manufacturing expertise, particularly for
security threads and watermarks, outside of Crane.  Of the 12
interested firms responding to our survey, only 3 foreign firms said
they can currently produce all 3 types of currency paper. 

According to BEP, there are four major currency paper manufacturers
that are internationally recognized in currency paper manufacturing
and security.  Only one of the four, Crane, is located in the United
States.  The other three, Portals Ltd., Papierfabrik Louisenthal, and
Arjo-Wiggins, are located overseas.  Portals Ltd., located in the
United Kingdom, said it has over 300 years of experience in supplying
currency paper to the British government and 40 other countries. 
Papierfabrik Louisenthal, located in Germany, has supplied banknote
paper to Germany since 1967.  Arjo-Wiggins, located in France, has
supplied banknote paper to France since 1789. 

American companies that we surveyed said that under the 90 percent
U.S.-owned or controlled interpretation, they have difficulty
attracting the interest of foreign companies in a joint venture in
which their expertise in currency production could be shared. 
Similarly, Portals, a foreign-owned paper manufacturer, told us it
built a paper manufacturing facility in Hawkinsville, GA, in 1980 for
two market segments:  U.S.  currency paper and high-security
documents.  According to Portals officials, they had been visiting
BEP for a number of years regarding their interest in providing
upgraded security features for U.S.  currency paper.  Portals
officials stated that on the basis of the favorable reception from
BEP, Portals built the Hawkinsville mill, which was capable of
producing 2,500 tons of paper a year immediately and had the
potential to move quickly up to 10,000 tons of paper a year. 
Ultimately, it was the passage of the Conte Amendment that caused
Portals to sell the Hawkinsville mill in 1988, according to Portals
officials. 

Reliance on a single domestic supplier for currency paper is not
unique to the United States.  In our survey of the other G-7
countries, Germany, France, and Italy said they restrict their
purchases of banknote paper to suppliers located in their countries. 
England and Canada said that they do not restrict their purchases of
banknote paper only to suppliers located in their countries. 
However, England has historically always purchased its paper from
Portals; and Canada competes both the manufacture of banknote paper
and the printing of the notes.  In Japan, the Japanese government is
responsible for producing the paper and printing banknotes. 

Secret Service officials strongly oppose any production of U.S. 
currency paper outside the United States because the Secret Service
does not have authority to exercise security oversight of the
personnel or plant facility in a foreign country.  The Secret Service
further stated that although it may be able to make agreements
allowing for such oversight, a foreign country's law could preclude
any investigative action or oversight by United States law
enforcement personnel.  The Secret Service also pointed out that the
logistics of moving a critical material across borders via a variety
of transportation modes would pose additional security risks.  BEP
security officials told us that they share the same concerns.  Secret
Service officials pointed out that they did not believe that the
percentage of foreign ownership would pose a security problem as long
as the paper is produced on U.S.  soil.  Officials from both the
Secret Service and BEP's Office of Security stated that because of
their concern about a catastrophe, they would be in favor of having
more than one supplier of currency paper, but they would strongly
prefer that suppliers be located in the United States. 

We agree that the Secret Service and BEP security officials have
valid concerns about the manufacture of U.S.  currency paper outside
the United States.  However, there are other components used for
currency production in the United States that are supplied by foreign
companies.  For example, BEP prints U.S.  currency on Swiss-designed
sheet-fed Intaglio printing presses made by De La Rue Giori; and it
buys the sheet currency inspection system and interim currency
inspection system from Giesecke & Devrient, located in Germany. 
Currency ink is bought from Sicpa, a Swiss-owned company, which has
facilities in the United States.  Additionally, the Federal Reserve's
high speed currency processing machines are made in Germany. 


--------------------
\10 Part B of the Conte Amendment contains a similar restriction on
passport paper. 

\11 H.R.  Report No.  104-183, 104th Cong.  1st Sess., at 22 (1995). 


         HIGH CAPITAL EQUIPMENT
         COST
------------------------------------------------------ Chapter 2:4.0.3

Six of the 12 interested paper manufacturers we surveyed said that
given the short length of a currency paper contract, the high cost to
finance capital equipment inhibits their ability to compete. 
Financing arrangements to assist these manufacturers could involve
extraordinary measures, such as the government sharing in the cost of
obtaining the capital equipment needed to build a currency plant by
providing government-furnished property or by financing contractor
acquired property (CAP).\12

According to one domestic manufacturer, a new supplier would incur
significant capital expenditures in order to meet BEP's requirements,
and the use of CAP would be essential to mitigate the capital
investment needed.  According to the 1996 Treasury/BEP study, the
estimated capital investment needed to produce currency paper
averaged $40 million and ranged from a low of $20 million to a high
of $150 million, depending on whether an existing mill could be
retrofitted or a new mill needed to be built.  Moreover, the
Treasury/BEP 1996 currency paper study also suggested that government
financing of potential contractors' equipment might be necessary to
secure competition for currency paper. 

In July 1996, BEP posted a draft of solicitation 97-13 on the
Internet stating that BEP would consider the feasibility of providing
CAP.  However, in May 1997, Treasury's former Director of Procurement
decided to remove CAP from the solicitation because, in his view, in
the form that it was being proposed by BEP, CAP would not have
increased competition.  The Treasury Procurement Director concluded
that a 4-year contract, inclusive of start-up time, would not allow
enough actual production time to generate sufficient revenues for the
contractors to make it worthwhile for them to risk the substantial
investment required to compete, even using CAP.  Treasury recommended
that BEP revise solicitation 97-13 to state that offerors would be
free to propose "innovative acquisition and financing arrangements."

One interested paper manufacturer told us that the removal of CAP
from the final solicitation and replacement with language that said
BEP would consider "innovative acquisition and financing
arrangements" left too much uncertainty about the capital investment
issue for the manufacturer to proceed with a proposal.  Two other
interested paper manufacturers said they would still be interested in
competing for the contract without CAP, if the length of the contract
were to be extended to at least 5 years. 


--------------------
\12 Under CAP, the government would advance some or all of the funds
needed to acquire or construct needed facilities.  This advance would
be factored into the evaluation of the price submitted by the
offeror, and the government could recover its CAP payment over the
life of the contract through decreased prices paid for paper it
ordered and would have title to the property acquired.  FAR allows
the use of CAP as a means to achieve competition but also requires
the elimination of any competitive advantage that this might create. 


         LENGTH OF START-UP PERIOD
------------------------------------------------------ Chapter 2:4.0.4

The start-up period historically allowed by BEP is too short,
according to five of the paper manufacturers we surveyed who were
interested in competing for BEP currency paper contracts.  One
domestic paper manufacturer said that a short start-up period permits
only the incumbent to submit an offer.  This paper manufacturer
further stated that the 24-month start-up period allowed by BEP in
solicitation 97-13 would result in the forfeiture of 2-1/2 years of
manufacturing, thus providing for less than the 4-year production
period.  The paper manufacturer further believes that the start-up
period should be added to the manufacturing contract, i.e., a 2-1/2
year start-up period followed by a 4-year contract; otherwise, no
paper company would invest in the specialized plant and equipment
that are required to meet the government's security paper production
needs before the contract is awarded.  Another domestic supplier said
that to prepare a facility for currency paper manufacturing would
take 1 to 2 years.  As noted previously, current law as interpreted
by BEP restricts the total period for currency paper production
contracts to 4 years. 

Prior to 1997, BEP required the supplier of currency paper to provide
currency paper immediately or shortly after contract award.  The
start-up period for all distinctive currency paper in solicitation
97-13 is up to 24 months. 


         OTHER FACTORS MENTIONED
         BY SOME PAPER
         MANUFACTURERS
------------------------------------------------------ Chapter 2:4.0.5

The requirements to pay a royalty license to use the data and process
for insertion of the security thread, the security requirements for
the manufacturing process, and the technology required to incorporate
anticounterfeiting features in paper were also cited as factors
inhibiting competition by 3 of the 12 paper manufacturers that were
interested.  One paper manufacturer filed a protest with BEP over the
security thread license and other issues relating to the current
solicitation.  Specifically, the paper manufacturer stated that the
solicitation places potential offerors, other than the incumbent, in
the position of violating a patent held by Crane if they supply
currency paper containing security thread made to the specifications
outlined by BEP.  According to this manufacturer, potential offerors
are effectively precluded from providing distinctive currency paper
with security thread and new currency design paper with watermark and
security thread.  In solicitation 97-13, BEP stated that it would
provide the security thread as government-furnished material. 
However, BEP would have to negotiate with Crane to buy the security
thread. 


   BEP HAS NOT SUCCESSFULLY
   OBTAINED ALTERNATIVE SOURCES
   FOR CURRENCY PAPER
---------------------------------------------------------- Chapter 2:5

BEP's attempts to develop alternative sources in the 1960s and 1980s
were not successful for a variety of reasons, including the
following: 

  -- One firm was unable to price its product competitively with
     BEP's traditional supply source for a portion of the currency
     paper requirement. 

  -- BEP discontinued its use of paper that another firm was
     developing. 

  -- The firm that had been developing paper that was discontinued
     needed technology from a foreign supplier to help it produce
     other types of paper that met BEP specifications. 

In 1996, BEP studied the possibility of developing a second currency
paper source.  It concluded that two sources would probably be more
costly than a single source, but it should continue to explore the
marketplace through competitive solicitations to determine if there
were viable alternative sources.  The costs used in the 1996 study
were based on an informal survey of paper producers that asked them
how much capital investment would be required to prepare paper for
BEP.  For production costs, BEP assumed that a second producer would
incur the same costs as Crane had.  BEP's analysis showed that a
second source, producing about 40 percent of BEP's needs, would
increase costs of producing paper by at least $21 million per year
and possibly $37 million per year, depending on the amount of capital
equipment the second producer acquired.  However, BEP's analysis did
not reflect its subsequent decision to accept a higher profit rate
with Crane to compensate for Crane's investment in capital equipment,
such as it did on the two most recent contract actions with Crane. 

Other agencies have found it advantageous to develop a second source. 
DOD officials told us that they have used a strategy referred to as
dual sourcing to develop a second supplier in a sole-source situation
for some weapon systems.  For example, according to Air Force
officials, dual sourcing was used to develop a second supplier to
purchase engines for F-16 fighters. 

Between 1967 and 1972, with few exceptions, the U.S.  Mint has
awarded the contracts for clad material\13 to one company.  However,
the Mint realized the vulnerability of having only one supplier, and
it attempted to develop additional sources by awarding developmental
contracts to firms that were interested in competing for future clad
material contracts.  However, the vendors selected were unable to
produce the material at an acceptable level of quality, according to
Mint officials.  Although the Mint did not have much success with
developmental contracts, it currently has more than one supplier,
according to Mint officials.  Since 1993, the Mint has purchased clad
material from two vendors that share 50 and 45 percent of the
contract, respectively.  The other 5 percent of the contract is
divided between two developmental contractors.  Mint officials told
us that they did not have a developmental contract with the Mint's
current second supplier, but the second supplier responded to a
competitive solicitation issued in 1993.  Mint officials said that
having two suppliers is better than one because competition helped
prevent prices of clad material from rising as rapidly as they would
have if there had not been any competition. 


--------------------
\13 Clad material consists of different metal alloys bonded together
and is used to produce 10-cent, 25-cent, and 50-cent coins. 


BEP HAS ENSURED QUALITY BUT HAS
NOT DEMONSTRATED THAT IT HAS
OBTAINED FAIR AND REASONABLE
PRICES
============================================================ Chapter 3

Although the long-term relationship between BEP and Crane has
historically provided quality currency paper, BEP did not generally
demonstrate that it obtained fair and reasonable prices for the
contracts, options, and extensions awarded between 1988 and 1997.  To
the contrary, the evidence available in the contract files showed
that BEP sometimes paid what it believed to be too high a price when
buying currency paper.  BEP's contracting officers recommended
accepting prices that they could not determine were fair and
reasonable with respect to five contracting actions because there was
no other source for currency paper.  BEP would not accept Crane's
proposed prices for half of the 10-year period covered by our review. 
Instead, BEP agreed to pay Crane's proposed prices as interim prices. 
The dispute was eventually settled by an arbitrator.  The major
disagreement between BEP and Crane involved profits until recently,
when BEP increased its negotiated profit objectives.\14

In determining whether Crane's proposed prices were fair and
reasonable, BEP relied primarily on audits of Crane's proposals. 
However, BEP has not obtained audits of Crane's cost estimating
system or post-award audits of some contracts until recently, made
little use of other cost analysis techniques in the earlier contracts
in our sample, and made very little use of price analysis.  Further,
some of BEP's procurement practices relating to the quantities of
paper ordered and its failure to obtain royalty-free rights to the
security thread caused, or may have caused, the government to pay
more for currency paper than it should have. 


--------------------
\14 Profit objective is the level of profit that BEP hoped to attain
during negotiations. 


   BEP HAS GENERALLY RECEIVED
   QUALITY PAPER
---------------------------------------------------------- Chapter 3:1

According to BEP officials, Crane has been a reliable source for
paper.  BEP and Crane officials said that a paper delivery to BEP has
not been missed in over 100 years.  BEP officials also said that the
overall quality of the currency paper supplied by Crane has been
good. 

In reviewing the files for currency paper contracts in effect from
1988 to 1997, we found only two references to problems with the paper
that Crane supplied to the government during this period.  The first
problem involved bonding of the security thread to the paper.  This
problem began in 1991 and was due to a change in the adhesive system
that was mandated by an environmental ruling in New Hampshire, where
the thread was produced.  BEP gave Crane a waiver to the contract
until the problem was solved in 1994.  According to BEP, the
resolution of this problem created a second problem, which involved
the inability of Crane to meet BEP's standards for the folding
endurance for the security threads.  The folding endurance standard
specifies how many times paper can be folded before it tears and is a
measure of durability.  The problem occurred in 1994, after the
thread bonding adhesion was changed, and it was brought to BEP's
attention by Crane.  BEP granted Crane a waiver from the folding
endurance standards for the contract in effect at the time (95-23)
and lowered the standard for the subsequent contract (97-10). 


   BEP USED LIMITED COST AND PRICE
   ANALYSIS
---------------------------------------------------------- Chapter 3:2

Of the five contracts awarded from 1988 to 1997, two were awarded on
a sole-source basis to Crane.  For the other three contracts, BEP
issued competitive solicitations.  Crane was the only company to
submit an offer.  In the absence of competition, BEP had to rely on
cost and price analyses to evaluate proposed prices to determine if
the prices paid for currency paper were fair and reasonable.  Price
analysis is to be used to verify that the overall price offered is
fair and reasonable in comparison with current or recent prices for
the same or similar items.  Examples of price analysis include
comparing proposed prices with (1) prices obtained for similar items
through market research, (2) parametric estimates such as dollars per
pound, and (3) previous prices. 

Under the Truth in Negotiations Act,\15 offerors are required to
submit and certify cost or pricing data to support the reasonableness
of individual cost elements, under certain circumstances, when
adequate price competition does not exist.  Separate cost elements
and profits are evaluated to determine how well the proposed costs
represent what the costs of the contract should actually be, assuming
reasonable economy and efficiency.  Examples of cost analysis include
the comparison of costs proposed for individual cost elements to
historical costs and the evaluation of the need for and
reasonableness of proposed costs.  Contracting officers are to
determine whether a proposed price is fair and reasonable on the
basis of both a cost analysis to ensure the reasonableness of
individual cost elements and a price analysis to ensure that the
overall price, including profit, is fair and reasonable.  The
contracting officer's determination is a judgment based on the
results of the cost and price analyses. 

For the most part, BEP limited its cost analysis techniques to audits
of Crane's price proposals.  The audits were done by the Treasury
Inspector General (IG) for contracts awarded before 1992 and by the
Defense Contract Audit Agency (DCAA) for contracts awarded after
1992.  The audits generally consisted of a review of the proposed
costs and a test of the reliability of the underlying data and
records supporting the proposed costs, as well as the accounting
principles used in developing the proposal.  In several of the
audits, the auditors qualified their work because of Crane's cost
accounting system.  For example, for contract 88-205, option 1, the
auditors observed that standard costs used in estimating were not
adjusted for actual variances, which made them less reliable as a
basis for estimation. 

BEP generally obtained audits of Crane's price proposals, but it did
not conduct a comprehensive price analysis for the five contracts we
reviewed.  BEP procurement records showed that it did not analyze the
changes in prices from one contract to the next and did not compare
proposed contract prices to the prices paid for similar items by
other government agencies or countries.  It did not always review
cost trends, such as product yield rates, material prices, and
proposed escalation over time, for the earlier contracts in our
sample.  More specifically, according to BEP's procurement records: 

  -- Audits of proposed costs were obtained for the first three
     contracts (88-205, 91-18, and 93-14) included in our review, and
     this information was used to evaluate Crane's proposed costs;
     however, additional cost or price analysis was not done for
     these contracts.  BEP stated that it did not have time to do a
     cost analysis for contract 91-18. 

  -- Audits of proposed costs were also obtained for contract 95-23,
     and this information was used to evaluate Crane's proposed
     costs.  BEP said that it performed additional cost and trend
     analysis. 

  -- For contract 97-10, BEP again used audit results and did more
     thorough cost analysis than it had previously done.  BEP also
     did limited price analysis; for example, it compared proposed
     prices to prices under its existing contracts. 

A BEP contracting officer said she attempted to obtain prices paid
for currency paper from some other governments by telephoning them,
but they said they were not willing to share this information due to
its proprietary nature.  We recognize that other governments may
consider such information to be proprietary or be unwilling to share
the information with an agency contracting official over the
telephone.  However, given the interest of the government in
achieving a fair and reasonable price in this unique market, other
more official and formal efforts to obtain the information, such as
inquiries from the Secretary of the Treasury or the State Department,
might be more successful. 

BEP procurement officials said they did not attempt to compare the
prices proposed for currency paper with the amounts the U.S.  Postal
Service paid for money orders or the Government Printing Office paid
for passport paper, because the products were different.  Although we
agree that the products are not identical, they are similar and they
are bought competitively.  The passport paper is cotton and pulp
based, has security thread, and contains a watermark.  Money orders
also have security threads and watermarks, but they are made from
wood pulp instead of cotton.  Nonetheless, although comparisons among
these types of products would not in themselves have provided a basis
for definite conclusions, they may have provided some insight for
assessing cost and price trends over time and in demonstrating the
effects of competition on prices. 

The only other analysis used by BEP was for negotiating contract
97-10, and it included an analysis of the effects of changes in
quantities ordered on Crane's production costs.  Similar analyses
would have been helpful for the other contracts we reviewed.  In
accordance with section 9003(b) of the 1997 Emergency Supplemental
Appropriations Act, the Secretary of the Treasury was required to
certify that the price for contract 97-10 was fair and reasonable and
that the terms of the contract were customary, appropriate, and in
compliance with procurement regulations.  The Secretary delegated
this determination to the Director of BEP, who made these
certifications on September 3, 1997. 


--------------------
\15 The Truth in Negotiations Act, codified at 41 U.S.C  254b for
civilian agencies, provides for a prospective contractor to submit
cost or pricing data in connection with the negotiation of certain
contracts when adequate price competition is not obtained.  The act
requires the prospective contractor to certify that the data are
accurate, current, and complete and provides for a possible price
reduction when the data are found to be inaccurate, incomplete, or
noncurrent. 


      RESULTS OF BEP'S
      DETERMINATIONS OF FAIR AND
      REASONABLE PRICES
-------------------------------------------------------- Chapter 3:2.1

The five contracts we reviewed from 1988 to 1997 and their options
and extensions resulted in 17 contract actions.\16 The prices for the
contracts and options are listed in appendix V.  For these 17
actions, BEP determined the price to be fair and reasonable for 4,
but it was not able to determine the price to be fair and reasonable
for 5.  BEP did not reach agreement on price for the remaining eight
contract actions.  For these eight, BEP used interim prices, which
were later finalized and reduced by an arbitrator. 

For the eight contract actions that were finalized by an arbitrator,
BEP and Crane were unable to reach agreement on (1) royalties paid to
Crane's affiliated subcontractor that produced the security thread,
(2) allocation of commercial sales commissions to government
contracts, (3) allocation of legal and consulting costs, and (4)
profit.  The arbitrator concluded in January 1995 that there was no
common control of the affiliated company producing the thread, the
allocation of Crane's sales commissions to government contracts was
not appropriate, and Crane's allocation of legal and consulting costs
was proper.  The arbitrator also decided that Crane was entitled to
higher profits than BEP had been willing to accept because of Crane's
needs for a fair return on its capital investments made to produce
paper with less labor.  The arbitrator commented that had the DOD
weighted guidelines been used, the government's and Crane's positions
would have been closer.  The DOD guidelines provide a structured
approach to develop a contract profit objective, and they emphasize
the usefulness of facilities' capital for buildings and equipment
used by the contractor to improve productivity or to provide other
benefits, such as improved reliability. 

The arbitrator decided that the settled price should be $212 million,
which was $9.7 million (4.4 percent) lower than the interim payments
that BEP had made to Crane.  According to the arbitration settlement,
billings for the subsequent 5 months of one contract action were also
settled.  During this period, BEP paid $2.1 million more in interim
payments than the settled amount, bringing the total amount returned
to BEP to $12.7 million. 

For 5 of the 17 contract actions, BEP was unable to determine the
prices to be fair and reasonable.  However, it accepted prices for
these five contract actions because, according to the BEP contracting
files, (1) there was no other source of paper and (2) the Federal
Reserve's currency requirements could not be met if the contract with
Crane were not awarded.  The major reason why BEP was not able to
determine the prices to be fair and reasonable was that BEP
contracting officers questioned the profit proposed by Crane.  In
general, BEP contracting officers were not willing to accept Crane's
proposed profit levels until after the award of contract 95-23, when
BEP modified its profit objective by adopting the DOD weighted
guidelines.  BEP's application of these guidelines resulted in BEP's
adoption of a higher profit objective. 

Crane told us that the use of the DOD guidelines resulted in a fair
return on the investment made in capital equipment with a minimum
amount of labor costs.\17

BEP's contract files did not indicate that any analysis was done to
demonstrate that on BEP contracts for which the DOD guidelines were
used to analyze profits, including contract 97-10, the profits were
beneficial to the government in that prices would be reduced, labor
costs would be reduced, or the government would otherwise benefit. 


--------------------
\16 Three contract actions, relating to contract 95-23, contained an
unpriced line item at the time of contract award.  This line item was
subsequently priced and considered to be fair and reasonable.  We did
not include this line item as a separate contract action. 

\17 The specific profit percentages negotiated for the BEP contracts
are proprietary information.  Crane asked that we not disclose that
information, other than to report that its negotiated profit rate was
19.6 percent in 1988, 11.8 percent in 1991, and 21.5 percent in 1995. 
Crane would not authorize us to disclose the negotiated profit
percentages for the other years in our review period, nor would it
provide the actual profit rates earned on currency paper. 


      BEP HAD INCOMPLETE AUDIT
      INFORMATION
-------------------------------------------------------- Chapter 3:2.2

Although BEP primarily relied on audits of Crane's proposals to
determine if the prices proposed were fair and reasonable, two
factors qualified the usefulness of these data.  First, in a 1994
post-award audit of a cost proposal, DCAA identified about $3 million
in over-pricing attributed to Crane's accounting system.  The
auditors observed that Crane's cost accounting system was based on
standard costs that were not periodically adjusted to reflect actual
costs.  Also, in several audit reports covering the proposals for
contracts we reviewed, DCAA reported that it had not been asked to
review the contractor's budgeting/estimating system. 

A second factor was the lack of post-award audits of the contractor's
costs for contracts 95-23 and 97-10.  In post-award audits, DCAA
attempts to verify whether the costs proposed were based on accurate,
complete, and current data as required by the Truth in Negotiations
Act.  BEP officials said that they asked for DCAA audits of the
contractor's budgeting/estimating system and post-award audits of
contracts 95-23 and 97-10 in May 1998.  BEP officials said they did
not ask for these audits earlier because the contractor's staff who
would be responsible for working with the DCAA auditors were engaged
in preparing cost proposals, and BEP did not want to interfere with
these activities. 


   UNECONOMICAL PROCUREMENT
   PRACTICES
---------------------------------------------------------- Chapter 3:3

Although unrelated to the issue of whether the government paid fair
and reasonable prices for currency paper, which is based on the
judgment of the contracting officer on the prices proposed for given
quantities of supplies, we also found that certain BEP procurement
practices contributed, or could have contributed, to higher than
necessary currency paper costs.  The practices included ordering
inconsistent quantities of paper, understating quantities expected to
be ordered, and not obtaining royalty-free data rights for security
thread used in U.S.  currency. 

According to a former Crane official we interviewed, BEP did not
order consistent amounts of the paper under the contracts. 
Consequently, Crane was not able to maintain a steady production
schedule and had to have more equipment than necessary to produce
paper to meet BEP's inconsistent ordering.  This official said there
were times when Crane's paper mill would be operating only a few days
a week due to lower-than-usual orders for paper; but at other times,
the mill would have to operate at full capacity for weeks in order to
fulfill a larger-than-usual BEP order.  Similarly, the BEP
contracting officer noted in an October 1996 trip report on a visit
to Crane that Crane requested BEP to commit to leveling out
production orders.  The contracting officer reported that Crane had
experienced four layoffs that year that were costly and could result
in the loss of skilled workers. 

The five contracts awarded from 1988 to 1997 were either fixed-price
requirements contracts or indefinite delivery/indefinite quantity
contracts.  Under either type of contract, the government provides an
estimate of the quantities of paper to be bought, and the contractor
proposes a price-per-sheet of paper based on that quantity.  Because
of the relatively high fixed costs in producing currency paper,
primarily due to high equipment costs, a higher volume equates to a
lower unit cost as the fixed costs are spread over more units. 
Because paper contracts are awarded on a price-per-sheet basis,
government orders in excess of the estimated quantity would be
expected to result in lower per sheet actual costs and increased
profit per sheet. 

For example, under the base period for contract 88-205, the
contractor provided a price of $.1254 per sheet, based on an
estimated quantity of 360 million sheets.  BEP actually bought 435
million sheets under this contract, which we estimate to have
contributed about $1.5 million in additional contract profits.  Other
contracts we reviewed also had differences between the estimated
contract quantities and the actual orders. 

A third issue involves BEP's failure to obtain royalty-free data
rights to the security thread used in currency and the process used
to insert the thread.  Crane, with its affiliated company, Technical
Graphics, Inc., holds patents for the thread and the process used to
insert the thread in the currency paper.  Although this thread is
unique to U.S.  currency, a BEP official said that the government
does not have the patents or a royalty-free license to use the thread
because the government never directly paid for their development. 
The BEP official said that in the early 1980s, Crane approached BEP
with an idea for the thread.  BEP encouraged Crane to develop it but
did not enter into a research and development contract with Crane to
develop the concept.  A BEP official observed that a research and
development contract would have been the vehicle for the government
to obtain an interest in the concept.  According to BEP officials,
Crane used its own funds to develop the thread and insertion process,
so Crane is entitled to the patents.  BEP officials also said that
the government indirectly paid for much of Crane's development
cost.\18 They said the government cannot obtain the royalty-free data
rights unless it contracts to do so. 


--------------------
\18 We were able to identify about $2.4 million of research and
development costs that Crane proposed and BEP accepted as independent
research and development to develop the security thread and the
process used to insert it into the currency paper.  However, the
extent to which other BEP funds may have been included in Crane's
contract costs is unclear because Crane did not segregate its
independent research and development costs by project. 


BEP IS NOW BUILDING AN INVENTORY
OF CURRENCY PAPER AS A CONTINGENCY
============================================================ Chapter 4

Although there have not been any disruptions in the supply of
currency paper for the last 119 years, BEP has not been in a good
negotiating position and has been vulnerable because it did not have
a second source for currency paper or have a reserve inventory of
currency paper.  The Conte Amendment allows BEP to contract with a
foreign entity if a domestic source is not available, thus providing
some relief if the current supplier were to encounter a catastrophic
incident and be unable to supply currency paper.  However, BEP
officials told us that a foreign source would require at least 3
months to prepare, produce, and ship watermark and threaded paper and
between 1 and 2 months to deliver currency paper without watermarks. 
BEP is in the process of establishing a 3-month contingency supply of
currency paper, which BEP expects to be completed in 1999. 

Although the longstanding single supplier has been a reliable source
of currency paper, the combination of relying on a single supplier
and not having an inventory placed BEP in a weak negotiating position
and presented some risks.  In BEP's price negotiation memorandums for
contracts 88-205 and 95-23, BEP's contracting officers stated that
despite the fact that they considered Crane's price to be too high,
BEP awarded contracts to Crane at the prices proposed by Crane in
order to ensure a continuous supply of currency paper. 

Furthermore, in a meeting between BEP and Crane to negotiate contract
95-23, the parties could not reach agreement over price.  The former
Chief Executive Officer of Crane said that "BEP would just have to
run out of paper," according to a memo written by a Treasury official
dated June 21, 1995.  Although BEP and Crane were eventually able to
reach agreement, the former Chief Executive Officer of Crane told us
that in June 1995 he told Treasury officials, in effect, that he
would not agree to another paper contract and that BEP would have to
run out of paper.  He said that this statement stemmed from issues
surrounding the arbitration settlement.  He said that a few months
earlier, Crane and BEP signed the agreement to accept the terms of
the arbitration settlement; however, BEP was still questioning the
prices covered by the agreement.  According to the former Crane
official, the only leverage Crane had to settle with BEP was to not
agree to enter into any new contracts. 

Under the Conte Amendment, if the Secretary of the Treasury
determines that no domestic source of currency paper exists in the
United States, the requirement for currency paper to be produced in
the United States and the prohibition against the purchase of
currency paper from a supplier owned or controlled by a foreign
entity would not apply.  In order to procure currency paper from a
foreign supplier, several actions would need to be taken.  First,
under the Conte Amendment, a written finding by the Secretary of the
Treasury justifying the basis for the determination that no domestic
manufacturer of currency paper exists must be published in the
Federal Register.  According to BEP officials, this could be done
within a matter of days.  Second, BEP would need to contract with
Crane to acquire the security thread so BEP could provide the thread
as government furnished property.  Finally, it would take the foreign
paper manufacturer about 3 months to start providing BEP with the
currency paper, according to BEP officials. 

To its credit, BEP recently decided to replace its "just-in-time"
approach to maintaining an inventory with a 3-month contingency
supply of currency paper.  According to its 1996 strategic
contingency plan for critical materials, BEP determined that a
3-month contingency supply of currency paper would be adequate.  BEP
officials said that they will have the inventory built up by 1999. 
According to the Federal Reserve, it maintains a 40-day supply of
finished currency at each of it reserve banks, which would also
provide some additional time to bring on another source of currency
paper if this were needed. 

In our survey of other G-7 nations, we were told that the amount of
banknote paper maintained in reserve ranged from 1 month in England
and Japan to 2 to 3 months in France and Italy.  In Canada, the
banknote printers are responsible for procuring their own banknote
paper.  Germany would not provide information on its inventory. 
Additionally, like the United States, none of the other G-7 nations
maintain a second supplier of banknote paper to protect against
possible disruptions in the supply of their banknote paper. 

BEP appears to be ahead of achieving its goal to have a 3-month
reserve for each denomination.  According to BEP, as of May 1998, it
has a 3-month reserve for each individual denomination with the
exception of the $20 denomination, which has been recently
redesigned.  BEP officials anticipate reaching the 3-month reserve
for the newly designed $20 note during calendar year 1999. 


CONCLUSIONS AND RECOMMENDATIONS
============================================================ Chapter 5

Obtaining competition in currency paper procurement is challenging,
partly because of the uniqueness of the currency paper, which
requires a relatively large investment in capital equipment.  In
addition, special statutory provisions govern the acquisition of
currency paper that provide a 4-year limit to contracts for the
manufacture of currency paper and that it be manufactured in the
United States, and prohibit the purchase of currency paper from
foreign-owned or controlled entities.  Although most BEP
solicitations issued before 1997 were competitive, it was not
successful in obtaining competition because no firm other than Crane
submitted an offer.  BEP efforts in the 1960s and 1980s to establish
a second source for currency paper also were not successful, for
similar reasons. 

We recognize that there are some uncertainties to the competitive
process, even if the existing problems are solved.  For example, 12
paper manufacturers told us that they are capable now, or would be in
the near future, of supplying at least part of BEP's currency paper
needs if further changes are made. 

However, we cannot say with any certainty how many, if any, would
submit an offer; whether they would be price-competitive with Crane;
or if the quality of paper and reliability of delivery would be
maintained.  In addition, 5 of the 12 paper manufacturers are
foreign-owned and are precluded from receiving a contract award under
current law. 

It is uncertain whether the government can successfully develop a
second domestic source for future paper needs, primarily because it
is unknown how prices would change.  Prices might increase if more
than one supplier were used.  For example, if the same quantity of
paper is obtained from two or more suppliers, each with substantial
capital investments, the unit price for paper is likely to be higher
from each.  Therefore, although having a second supplier could lessen
the government's vulnerability to a disruption in supply, having two
suppliers could result in an increased cost to the government.  On
the other hand, a single supplier has less incentive to be efficient
or to keep prices and costs to a minimum than suppliers who have to
compete with each other, and DOD has reportedly benefited from having
a second source in some instances. 

In its most recent currency paper solicitation, BEP has taken several
actions to encourage competition, including providing up to 24 months
for potential suppliers to start production for currency paper with
additional security features and providing for longer contract
performance periods, within the statutory 4-year limit.  However, if
these steps are not sufficient to encourage offers from additional
suppliers, additional actions to promote competition by Treasury and
BEP may be appropriate.  Given the current statutory constraints;
previous efforts to study this problem, as well as Treasury's ongoing
study of future currency demand, which could affect the economic
viability of having more that one currency paper supplier; and
uncertainties discussed in our report, we believe it is premature to
recommend specific steps at this time.  Moreover, additional insight
on this issue should be available after Treasury completes its
ongoing study on future currency demand and as other information
becomes available, such as the currency paper prices BEP obtains
under its current solicitation and any changes in legislation
affecting currency paper procurement that might occur. 

BEP has not generally been adequately prepared to be in a position to
know what it should be paying for currency paper because, until
recently, it has done only limited cost analysis and has not used
price analysis.  BEP could improve some aspects of its currency paper
procurements.  The evidence demonstrates that BEP (1) lacked an
aggressive effort to encourage Crane to develop an acceptable cost
accounting system; (2) did not always arrange for post-award audits
and audits of the supplier's cost estimating system; (3) did not
include data and analyses in the procurement record that demonstrated
the benefit that BEP was to receive when it approved profits that
were to recognize or provide an incentive for capital investment; (4)
conducted limited analysis of supplier costs and prices, in the
context of the worldwide market for currency paper; (5) failed to
accurately estimate the amount of paper it needed to procure and
ordered inconsistent amounts of paper; and (6) did not take action to
arrange for royalty-free access to security thread.  In addition to
actions to correct these problems, recent efforts to establish a
3-month inventory of currency paper should provide an additional tool
to help BEP better ensure that fair and reasonable prices can be
achieved. 

As noted above, BEP has taken several actions to encourage
competition.  For example, BEP extended the period for potential
suppliers to start production for currency paper with additional
security features and provided for longer contract performance
periods than it had in the past.  However, BEP must acquire currency
paper within the existing legal framework.  According to BEP, the
legal framework requires that offerors' start-up period be included
in the 4-year contract period, thus reducing the manufacturing period
and limiting the effect of BEP's actions.  According to BEP, the
4-year statutory limit on contracts was created in 1916 to extend the
contracts beyond the 1-year statutory limit then in effect, in order
to better ensure a reliable supply of materials.  BEP's options for
encouraging competition could be further enhanced if Congress
lengthened the 4-year limit for currency paper contracts to give
potential offerors a longer time to recover their capital
investments. 

If efforts to obtain competition continue to be unsuccessful, BEP's
capacity to achieve fair and reasonable prices could be enhanced
through congressional action.  BEP's strategy options could be
further strengthened if Congress provided additional authority by
modifying the Conte Amendment's prohibition on procuring currency
paper from foreign-owned or controlled suppliers to permit the
Secretary of the Treasury to do so on a temporary basis if it is
determined that currency paper is not available from a domestic
source at fair and reasonable prices.  Such a modification could
provide additional leverage for the government in its negotiations
with the current supplier, or any future domestic supplier(s), and
increase the likelihood that fair and reasonable prices can be
achieved. 


   RECOMMENDATIONS TO THE
   SECRETARY OF THE TREASURY
---------------------------------------------------------- Chapter 5:1

To strengthen BEP's capacity to ensure fair and reasonable prices, we
recommend that the Secretary direct BEP to

  -- ensure that the contractor maintains acceptable cost accounting
     and estimating systems for future contracts and that they are
     periodically audited;

  -- arrange for post-award audits of the contractor's costs;

  -- include data and analyses in the currency paper procurement
     record that demonstrate the benefits the government is to
     receive when it approves profit levels that are aimed at
     recognizing or providing an incentive for capital investments;
     and

  -- to the extent possible, make more extensive use of price
     analysis to determine the fairness and reasonableness of prices,
     including the collection of data from foreign countries on their
     currency prices and data on similar supplies purchased by other
     agencies, such as paper for passports and money orders. 

To further enhance opportunities for other paper manufacturers to
offer to provide currency paper to the government and to obtain
offers that represent the best value to the government for the paper,
we also recommend that the Secretary ensure that all future currency
paper procurements reflect the expected amounts of paper needed and
orders against contracts are for consistent amounts.  This would
allow the supplier(s) to maintain a steady production level and
stabilize workforce levels.  Finally, we recommend that the Secretary
ensure that the government obtains royalty-free data rights to any
future security measures incorporated into currency paper. 


   MATTERS FOR CONGRESSIONAL
   CONSIDERATION
---------------------------------------------------------- Chapter 5:2

To further assist the Secretary in obtaining competition from
domestic sources, Congress may wish to consider lengthening the
4-year limit for currency paper contracts to give potential offerors
a longer time to recover their capital investments.  If adequate
price competition among two or more suppliers can be achieved,
concerns over whether the prices paid are fair and reasonable should
be reduced. 

Finally, because BEP's past efforts to encourage domestic competition
for currency paper have been unsuccessful and future efforts are
uncertain, and because BEP has not always been able to ensure fair
and reasonable prices from the current supplier in some past
procurements, additional authority may be necessary to protect the
government's interests in obtaining currency paper.  Specifically,
Congress may want to consider revising the Conte Amendment, which
allows the Secretary of the Treasury to obtain currency paper from a
foreign-owned source only if no domestic supplier is available, to
permit the Secretary to authorize obtaining currency paper from a
foreign-owned source on a temporary basis if it is determined that no
domestic supplier will provide paper at fair and reasonable prices. 
Such a provision should improve the likelihood that fair and
reasonable prices could be obtained. 


   AGENCY AND CRANE & CO. 
   COMMENTS
---------------------------------------------------------- Chapter 5:3

We provided copies of a draft of this report for comment to the
Chairman of the Board of Governors of the Federal Reserve System, the
Acting Director of BEP, the Secretary of the Treasury, and the Chief
Executive Officer of Crane.  On July 29, 1998, the Assistant to the
Board of Governors of the Federal Reserve System provided oral
comments on our draft report.  He said the Federal Reserve considered
the analysis and recommendations to be reasonable.  We also received
written comments from the Acting Director of BEP, dated July 29,
1998, which are reprinted in appendix VI; and we received written
comments from Crane dated July 28, 1998, which are reprinted in
appendix VII.  According to BEP officials, the BEP comments included
input from the Department of the Treasury. 

Finally, in a meeting with us on July 29, 1998, BEP provided a number
of oral technical clarifications to our report that we made where
appropriate. 


      BEP COMMENTS
-------------------------------------------------------- Chapter 5:3.1

The Acting Director of BEP stated that our report does not recognize
that BEP complied with the FAR in the award of the five contracts we
reviewed and provided comments on our recommendations.  We did not
make a comprehensive assessment of BEP's compliance with FAR in
connection with the five contracts we reviewed and thus are not in a
position to make an overall statement on BEP's compliance. 

Our draft report included recommendations that BEP (1) consider
amending solicitation 97-13 and future solicitations to provide
financial assistance if deemed to be economically advantageous to the
government; and (2) consider excluding Crane from some or all of
BEP's currency paper requirements, as an example of a strategy to
establish an alternative source.  In its comments, BEP endorsed the
idea of providing financial assistance but did not agree with
amending solicitation 97-13 because it believes solicitation 97-13
provided for financial assistance.  In addition, BEP said that
Treasury is currently studying the future demand for currency, and
once the study is completed, BEP will be in a better position to
assess the cost reduction potential associated with developing
additional suppliers.  BEP also disagreed with our recommendation
that Treasury consider excluding Crane from some or all of BEP's
currency paper requirements.  BEP said that excluding Crane from
competing for all of its requirements was not feasible because of the
lack of an alternative domestic source; and excluding Crane from part
of its requirements would not be practical or economically feasible,
citing a previous determination that the price for currency paper
could increase significantly due to the high capital investment cost
for a potential new supplier. 

After carefully considering BEP's comments as well as reconsidering
the uncertainties we identified in our draft report, we agree with
BEP that amending solicitation 97-13 to offer financial assistance
and excluding Crane from all of its requirements could create
difficulties for BEP in meeting its responsibilities to ensure an
adequate supply of currency paper.  We also agree with BEP that it
should be in a better position to evaluate the feasibility of
establishing additional suppliers after Treasury completes its
ongoing study of future currency demand, which Treasury expects to be
done soon.  In fact, our draft report recognized that future currency
paper demand was one of the factors that needed to be considered in
deciding on the feasibility of additional suppliers. 

Accordingly, we deleted our recommendations to the Secretary aimed at
encouraging competition to reflect BEP's concerns, the uncertainties
identified in our report, and because of Treasury's ongoing effort to
project future currency demand.  However, we believe that future
consideration by Treasury of additional measures to encourage
competition may be appropriate after it finishes its study of future
currency demand for a number of reasons.  First, significant changes
in future currency demand could affect the economic feasibility of
establishing other suppliers.  Second, BEP's statement that it has
determined that establishing another supplier would not be
economically advantageous appears to be based on its 1996 currency
paper study, which was done before BEP accepted higher prices for
newly designed currency paper under contract 97-10; higher prices
could affect the conclusions Treasury reached in its 1996 study. 
Third, Treasury's report on its 1996 currency paper study did not
fully address the economic feasibility of establishing a second
supplier under different scenarios that would be possible if existing
restrictions on the contract period or percentage of foreign
ownership and control were changed. 

Regarding our recommendation to ensure the contractor maintains
acceptable cost accounting and estimating systems, BEP said that it
has audited the contractor's cost accounting practices and will
continue to do so.  However, on July 29, 1998, BEP officials told us
that they still had not obtained an audit of Crane's estimating
system.  We believe that this should have been done earlier because
the estimating system helps to ensure that cost proposals are based
on reliable and consistent data. 

In reference to our recommendation to arrange for post-award audits
for the contractor's costs, BEP said that it had requested audits and
that ongoing IG and DCAA investigations and audits occasionally
interfered with timely post-award audits.  We believe BEP should
continue to pursue these audits because past efforts to follow up on
obtaining post-award audits have not always been timely and because
they help protect the government's interests. 

With respect to our recommendations that solicitations reflect
expected paper needs and that orders be evened out, allowing the
supplier to maintain a steady production level, BEP agreed that
improvements were needed and says it has taken corrective actions to
ensure that the quantities bought under contract 97-10 represent
actual requirements.  We believe these actions are a step in the
right direction and should be continued in future orders of currency
paper. 

BEP disagreed with our recommendation that it make more extensive use
of cost and price analysis.  BEP pointed out that in its two most
recent contracts, it had applied a number of cost analysis
techniques.  Our draft report recognized that BEP had done more cost
analysis on contract 97-10 than had been done in previous contracts. 
However, BEP did not do adequate price analysis for any of the five
contracts we reviewed, including 97-10, and did not do adequate
analysis to support the profit levels it accepted.  Accordingly, we
modified our recommendation to address the need for greater analysis
of proposed profit levels.  Regarding our recommendation to collect
pricing data from foreign countries, BEP said it would continue to
try to obtain foreign country currency paper data.  We added some
language to the report to clarify how this might be done.  With
respect to the related suggestion that BEP collect pricing data on
similar supplies purchased by other agencies, such as passport and
money order paper, BEP said it believed comparison of currency paper
prices to passport and money order paper would not produce any
meaningful information.  BEP said these papers are different from
currency paper.  Our report recognizes that although comparisons of
these types of papers would not provide a basis for a definitive
conclusion, they may provide some insight for assessing pricing
trends. 

BEP said it agreed with our recommendation to obtain royalty-free
data rights to future security measures.  BEP pointed out that the
cost of such royalties for the security thread is less than 0.2
percent of the cost of the currency paper contract.  However, BEP did
not address the effect these patents had on its 1997 competitive
solicitation or could have on future solicitations.  As discussed in
chapter 2, several paper manufacturers stated that the requirements
to pay a royalty license to use the data and process for insertion of
the security thread made it difficult for them to compete.  One paper
manufacturer filed a protest with BEP over the security thread
license and said that the solicitation places potential offerors in a
position of violating a patent held by Crane if they supply currency
paper containing security thread made to BEP's specifications.  In
response to this protest, BEP agreed to provide the security thread
as government-furnished property. 


      CRANE & CO.  COMMENTS
-------------------------------------------------------- Chapter 5:3.2

Crane provided very lengthy comments on many of the issues addressed
in this report.  Our specific responses to the comments are included
in appendix VII.  In general Crane said that although it agreed with
many of our factual findings, it disagreed with most of our
recommendations and one of our matters for consideration of Congress. 
Crane also suggested specific technical changes to clarify our report
that we have made where appropriate. 

In objecting to our recommendations that BEP and Treasury take
further steps to encourage competition in the supply of the nation's
currency paper, Crane said that they have already been adopted by BEP
and no further action was necessary.  Crane specifically objected to
the recommendations in the draft report that BEP further consider
options for providing financial assistance to other potential
suppliers and that BEP consider excluding Crane from all or some of
its currency paper requirement to encourage participation by other
potential suppliers.  While these strategies are permitted under law,
Crane said that they would result in higher costs and possible
disruptions to the supply of currency paper.  As we explain in
response to BEP's concern about these recommendations, we acknowledge
and stress in the report that the impact of alternative strategies is
uncertain and that many factors would have to be weighed in
considering any option.  In light of BEP's concerns and to recognize
the uncertainty involved, we have deleted the recommendations
proposed in our draft report to encourage Treasury and BEP to further
consider the feasibility and advisability of additional measures to
encourage competition. 

Crane agreed with our suggestion to Congress that consideration be
given to modifying the 4-year limit on currency paper contracts. 
However, Crane opposed our further suggestion to Congress that the
Secretary of the Treasury be given additional authority to acquire
currency paper from foreign-owned firms in the event that fair and
reasonable prices cannot be obtained from a domestic source.  We can
understand Crane's position on this matter, since it believes that
its prices have been fair and reasonable, and that the alternative of
acquiring currency paper from a foreign source is not necessary. 
However as our report clearly states, there have been occasions in
the past in which BEP has not been able to determine that Crane's
prices were fair and reasonable, but the lack of other domestic
suppliers and the current restriction prohibiting acquiring currency
paper from foreign-owned sources unless no domestic source exists has
limited the negotiating strategies.  For these reasons, we continue
to believe that Congress should consider limited expansion of the
Secretary's authority. 


OBJECTIVES, SCOPE, AND METHODOLOGY
=========================================================== Appendix I

Section 9003 of the fiscal year 1997 Emergency Supplemental
Appropriations Act required that we complete "a comprehensive
analysis of the optimum circumstances for government procurement of
distinctive currency paper" and report our findings to the House and
Senate Committees on Appropriations.  According to the conference
report accompanying the appropriations bill, the Conference Committee
expressed concern over the fact that BEP has bought virtually all of
its paper for the nation's currency from a single supplier for over
100 years.  The Conference Committee directed that we report on any
limitations on competition in currency paper procurement and possible
alternatives to the way BEP has been buying the paper, the fairness
and reasonableness of prices paid for the paper, the potential for
disruption of currency paper from relying on single supplier, and
other matters. 

In June 1997, the Chairman of the House Government Reform and
Oversight Committee asked that we also report our findings to that
Committee because of its interests in federal procurement matters. 
Senator Lautenberg, in June 1997, also requested that we report our
findings to his office.  In September 1997, 16 Members of Congress
informed us of their interest in ensuring that our analysis was
carried out in an objective manner and expressed their opinion that a
review of the potential benefits and drawbacks of a single supplier
relationship was appropriate. 

As a result of the large number of congressional parties interested
in this matter and because the public law that initiated it contained
a general statement that we analyze "the optimum circumstances for
government procurement of distinctive currency paper," we met with
the interested Members' staffs to obtain the specific issues they
wanted addressed, and we suggested approaches to address those
issues.  We identified numerous concerns and issues, which are
covered under the following three broad objectives: 

  -- Have BEP's efforts to encourage competition for currency paper
     been effective? 

  -- Have prices paid for currency paper been fair and reasonable and
     has the quality of paper been ensured? 

  -- Is there potential for disruption to the U.S.  currency paper
     supply from BEP's reliance on a single supplier? 

To address the first objective, the effectiveness of efforts to
encourage competition for currency paper, we reviewed BEP procurement
files for 5 contracts with 17 procurement actions awarded during 1988
to 1997 and the current solicitation.  We also reviewed the 1983 and
1996 Department of the Treasury/BEP studies on currency paper
procurement.\19 We interviewed and obtained documents from officials
at BEP, Treasury, Crane, and the Federal Reserve. 

In addition, we identified and surveyed 30 paper manufacturers of
cotton-based security paper to determine their interest in and
ability to supply currency paper to BEP.  We identified the 30
manufacturers by (1) reviewing the 1996 Treasury/BEP currency paper
study, which identified 7 producers; (2) reviewing the Lockwood-Post
Directory of Pulp, Paper, and Allied Trades, 1995 edition, which
listed 21 producers; and (3) interviewing a representative of the
American Forest and Paper Association's Cotton Fiber Council, who
identified 9 producers.  The three sources, in some cases, identified
the same producers.  In total, we identified 30 different producers. 
See appendix IV for a copy of our questionnaire. 

Our primary variable for analysis was interest in providing currency
paper to BEP.  We considered the 12 manufacturers who responded with
"very interested" and "somewhat interested" in providing currency
paper to BEP our most important group for the purposes of this study
because they have a stated interest in supplying paper to BEP.  These
are referred to in our text as the "interested paper manufacturers."
Of these 12, 7 were domestic and 5 were foreign manufacturers. 

We conducted site visits to two paper manufacturing facilities, Crane
in Dalton, Massachusetts; and FiberMark, Inc., in Bloomsbury, New
Jersey.  We selected Crane because it has been the long-standing
single supplier of currency paper to BEP.  The second manufacturing
facility we visited was FiberMark, Inc., which was selected because
of its expressed interest in competing to become a U.S.  currency
paper supplier. 

To obtain a perspective on how other countries procure banknote
paper, we sent a separate questionnaire to representatives of the
other G-7 nations:  Canada, England, France, Germany, Italy, and
Japan. 

We analyzed the Conte Amendment and its legislative history, the
statute limiting the procurement of distinctive currency paper to
4-year contracts, and other applicable procurement laws and
regulations to identify requirements affecting the procurement of
currency paper.  We interviewed Secret Service and BEP procurement
and security officials regarding off-shore manufacturing
issues--specifically, the security concerns that may have an impact
on opportunities for competition.  We also interviewed officials at
the U.S.  Mint; Government Printing Office; U.S.  Postal Service; and
the Departments of the Army, Navy, and Air Force to identify possible
alternatives to BEP's approach to procuring currency paper. 

For our second objective, to determine the fairness and
reasonableness of price and assurance of quality goods and services,
we reviewed BEP procurement records from 1988 to 1997.  Originally,
we planned to review the files for currency paper contracts awarded
by BEP for the past 15 years.  However, BEP contract files contained
records for only a 10-year period, 1988 through 1997.  We examined
documents in the files, such as price negotiation memoranda, cost and
price analyses, and other supporting documents, to determine whether
the contractor had provided the government with a quality product at
a fair and reasonable price.  We also reviewed Treasury IG and DCAA
audit reports relating to the supplier's cost proposals and cost
accounting system. 

To help us review the fairness and reasonableness of BEP prices, we
contracted with Joe D.  Quicksall, a consultant with specialized
experience in procurement issues.  Mr.  Quicksall, who is a GAO
retiree, added to this review his extensive knowledge of fair and
reasonable pricing issues gained over his more than 30 years of
auditing experience. 

Mr.  Quicksall analyzed the supplier's cost proposals and the related
IG and DCAA audit reports to assess how BEP used these data to
evaluate and negotiate costs.  Mr.  Quicksall examined the impact of
an arbitration decision related to questioned contract costs and
profit and provided his opinion on BEP's basis for determining
fairness and reasonableness of price for contracts awarded from 1988
to 1997.  Finally, we obtained IG/DCAA audit reports and interviewed
BEP, IG, and DCAA staff concerning defective pricing practices of the
currency paper supplier.  We also interviewed BEP officials and
reviewed BEP's procurement records to obtain information on the
quality and reliability of Crane's currency paper deliveries. 

To address the third objective, the potential disruption to the U.S. 
currency paper supply from BEP's reliance on a single supplier, we
reviewed inventory reports and BEP's contingency plan for critical
materials; and interviewed officials at BEP, the Federal Reserve, and
the current supplier to determine current inventory levels, the
potential for disruption to the supply of currency paper, and what
steps, if any, would have to be taken to procure currency paper if it
could not be obtained from Crane.  We also toured the BEP facilities
in Washington, D.C.; and Fort Worth, TX; and the Federal Reserve Bank
in Dallas, TX, to determine the storage capacity for currency paper
inventory.  In addition, by survey, we collected information on
currency paper inventories maintained by the other G-7 countries. 

We conducted our review in Washington, D.C.; Dallas and Fort Worth,
TX; Dalton, MA; Bloomsbury, NJ; and Hartford, CT, from June 1997
through August 1998, in accordance with generally accepted government
auditing standards.  We obtained written comments on a draft of this
report from BEP and Crane.  These comments are reprinted in
appendixes VI and VII and are discussed at the end of chapter 5. 


--------------------
\19 Review of Distinctive Currency Paper, Aug.  1983, and the U.  S. 
Currency Paper Study, June 1996.  The 1983 study was initiated to
determine whether alternative sources of distinctive currency paper
were available to BEP.  Concerns about a single supplier of currency
paper prompted the 1996 study, which was undertaken to determine
options for ensuring a reliable source of currency paper at a
reasonable price. 


SYNOPSIS OF SIX PAPER CONTRACTS
REVIEWED
========================================================== Appendix II

88-205 was a procurement action classified as a competitive
solicitation that resulted in a letter contract awarded to Crane in
December 1987.  Crane was the only firm to submit a proposal to BEP
for distinctive currency paper for 1-dollar and 2-dollar notes.  The
contract was for a 2-year period, with two 1-year options,
definitized in May 1988, with an estimated value of $45,144,000. 
Option year one was exercised effective May 1990, and option year two
was exercised in May 1991.  At the completion of option year two, the
contract was extended for 6 months. 

91-18 was a procurement action classified as a competitive
solicitation.  The contract was awarded to Crane in February 1991,
the only firm to submit a proposal.  The solicitation was to
manufacture denominated distinctive currency paper with security
thread, specifically, 20-, 50-, and 100-dollar notes.  The contract
was for a 1-year period with three 1-year options, with an estimated
value of $66,309,320.  All options were exercised on the anniversary
date of the contract, and the contract was also extended from
February 1995 to May 1995. 

93-14 was a procurement action classified as a competitive
solicitation.  The contract was awarded to Crane in January 1993, the
only firm to submit a proposal to BEP.  The solicitation was to
manufacture distinctive currency paper.  The contract was for a
1-year period with four 1-year options with an estimated value of
$16,471,779.  Option one was exercised on the anniversary date of the
contract.  The remaining options were not exercised. 

95-23 was a sole-source contract awarded to Crane in June 1995 for
the manufacture of all three types of paper currently being used,
distinctive currency paper, distinctive paper with a security thread,
and the new currency design paper containing security thread and a
watermark.  The contract was for a period of 1 year, with two 6-month
options and with an estimated value of $54,342,281.  The new currency
design paper was not priced in the initial contract but was priced in
a modification. 

97-10 was a sole-source contract awarded to Crane in September 1997
for the manufacture of all three types of currency paper.  The
contract, known as the bridge contract, is for a period of 2 years,
with no options and at an estimated value of $171,458,298. 

97-13 is a competitive solicitation for a possible 4-year contract to
manufacture three types of currency paper and is expected to be
awarded in December 1998. 


INTERESTS OF PAPER MANUFACTURERS
RESPONDING TO GAO'S SURVEY
========================================================= Appendix III

Table I.1 lists the 30 paper manufacturers to which we sent our
questionnaire, identifies those that responded, and identifies those
that stated that they were interested in supplying currency paper to
BEP. 



                    Table III.1 Paper Manufacturers
                 Participating in GAO's Currency Paper
                                 Survey

                                                    Interested in
                                Responded to        supplying currency
Paper Manufacturer              survey?             paper to BEP?
------------------------------  ------------------  ------------------
Arjo-Wiggins                    Yes                 Yes
Paris, France

Boise Cascade                   Yes                 Yes
Portland, OR

Buckeye Cellulose Corp.         No                  No
Memphis, TN

Cheney Pulp & Paper             No
Franklin, OH

Cottrell Paper Co.              Yes                 No
Rock City Fall, NY

Cross Pointe                    No
Dayton, OH

Crown Vantage                   Yes                 Yes
Milford, NJ

Domtar Security Papers          Yes                 Yes
Montreal, Canada

Eastern Paper                   No
Amherst, MA

Esleek Manufacturing            Yes                 No
Turner Falls, MA

FiberMark                       Yes                 Yes
Bloomsburg, NJ

Filter Materials                Yes                 No
Waupaca, WI

Fletcher                        Yes                 Yes
Alpena, MI

Fox River Paper                 Yes                 Yes
Appleton, WI

Fraser Paper Company            No
Stamford, CT

Georgia Pacific                 Yes                 No
Port Edwards, WI

Gilbert Paper                   Yes                 Yes
Menasha, WI

International Paper Co.         Yes                 Yes
Memphis, TN

Knowlton Specialty Papers       No
Watertown, NY

Louisenthal                     Yes                 Yes
Frankfurt, Germany

Lunday Thagard Company          No
South Gate, CA

Neenah Paper                    Yes                 No
Neenah, WI

NVF Company                     No
Yorklyn, DE

Parsons Paper Company           No
Holyoke, MA

Portals                         Yes                 Yes
Overton, United Kingdom

Rolland, Inc.                   Yes                 No
Quebec, Canada

Southworth Company              Yes                 No
West Springfield, MA

Spexel                          Yes                 Yes
Quebec, Canada

Strathmore Paper                Yes                 No
East Granby, CT

Wausau Papers of New            No
Hampshire
Groveton, NH

======================================================================
Total                           20                  12
----------------------------------------------------------------------



(See figure in printed edition.)Appendix IV
GAO'S PAPER MANUFACTURERS SURVEY
========================================================= Appendix III



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)


PRICES FOR CURRENCY PAPER ON FIVE
CONTRACTS GAO REVIEWED
=========================================================== Appendix V



                               Table II.1
                
                  Per Sheet\a Prices of Currency Paper
                Ordered for Five Contracts GAO Reviewed

                                         Types of paper
                           -------------------------------------------
                                                         Threaded with
Contract                      Unthreaded       Threaded      watermark
-------------------------  -------------  -------------  -------------
88-205
Letter contract                   $.1240
Base period (2)                    .1254
Option I                           .1542
Option II                        .1542\b
Extension                        .1542\b
91-18
Base period (1)                                  $.3932
Option I                                        .2977\b
Option II                                       .2686\b
Option III                                      .2627\b
Extension                        .1550\b
93-14
Base period (1)                  .1599\b
Option I                         .1640\b
95-23
Base period (1)                    .1643          .2484        $ .4230
Option I (6 mos.)                  .1633          .2452          .4036
Option II                          .1641          .2456          .4034
 (6 mos.)
97-10
year 1                             .1802          .2471          .4480
year 2                             .1705          .2375          .4818
----------------------------------------------------------------------
\a Contract prices are given on a per-sheet basis.  Each sheet
produces 32 currency notes. 

\b Prices shown are interim prices that were settled at a lower price
in arbitration on an aggregate contract basis. 

Source:  BEP contract files. 




(See figure in printed edition.)Appendix VI
COMMENTS FROM THE DEPARTMENT OF
THE TREASURY AND THE BUREAU OF
ENGRAVING AND PRINTING
=========================================================== Appendix V



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)




(See figure in printed edition.)Appendix VII
COMMENTS FROM CRANE & CO. 
=========================================================== Appendix V

Now on p.  6. 

See comment 1. 



(See figure in printed edition.)

See GAO comment 3. 



(See figure in printed edition.)

See GAO comment 3. 

See GAO comment 4. 

See GAO comment 4. 

See GAO comment 1. 



(See figure in printed edition.)

See GAO comment 5. 

See GAO comment 6. 

See GAO comment 7. 



(See figure in printed edition.)

See GAO comment 7. 

See GAO comment 6. 

See GAO comment 8. 

Now on pps.  7-8. 

See GAO comment 9. 

See GAO comment 4. 



(See figure in printed edition.)

See GAO comment 6. 

See GAO comment 10. 

See GAO comment 6. 

See GAO comment 2. 

See GAO comment 6. 

Now on pps.  33 and 41. 

See GAO comment 8. 

See GAO comment 8. 

See GAO comment 11. 



(See figure in printed edition.)

Now on p.  5. 

See GAO comment 12. 

See GAO comment 12. 

See GAO comment 13. 

See GAO comment 13. 



(See figure in printed edition.)

Now on p.  22. 

Now on p.  22. 

See GAO Comment 13. 

See GAO comment 14. 



(See figure in printed edition.)

See GAO comment 15. 

Now on pp.  27-28. 

See GAO comment 16. 

See GAO comment 15. 



(See figure in printed edition.)

Now on p.  32. 

See GAO comment 13. 

Now on p.  44. 

See GAO comment 17. 



(See figure in printed edition.)

See GAO comment 17. 

Now on p.  5. 

See GAO comment 19. 



(See figure in printed edition.)

Now on p.  18. 

Now on pps.  6-7. 



(See figure in printed edition.)

Now on p.  16. 

Now on pp.  15-16 and 28. 

See GAO comment 20. 



(See figure in printed edition.)

See GAO comment 21. 

See GAO comment 20. 

See GAO comment 7. 

See GAO comment 23. 

See GAO comment 22. 

See GAO comment 22. 



(See figure in printed edition.)

Now on pp.  4 and 41. 

See GAO comment 22. 

Now on p.  22. 

See GAO comment 22. 

See GAO comment 22. 

Now on p.  43. 

See GAO comment 22. 

Now on p.  43. 

See GAO comment 22. 



(See figure in printed edition.)

Now on p.  43. 

See GAO comment 22. 

See GAO comment 22. 

Now on p.  44. 



(See figure in printed edition.)

Now on p.  29. 

See GAO comment 23. 

See GAO comment 24. 

See GAO comment 24. 



(See figure in printed edition.)

See GAO comment 26. 

See GAO comments 7 and 13. 

Now on p.  24. 



(See figure in printed edition.)



(See figure in printed edition.)

See GAO comments 4 and 7. 

See GAO comments 6 and 7. 

See GAO comments 6 and 7. 



(See figure in printed edition.)

See GAO comments 6 and 7. 

See GAO comment 6. 

See GAO comment 25. 

See GAO comment 6. 



(See figure in printed edition.)

See GAO comment 6. 

See GAO comment 26. 

Now on p.  34. 



(See figure in printed edition.)

See GAO comment 26. 

Now on pp.  34-35. 



(See figure in printed edition.)



(See figure in printed edition.)

See GAO comment 27. 

Now on p.  40. 



(See figure in printed edition.)

See GAO comment 2. 

See GAO comment 2. 

Now on p.  8. 

See GAO comment 32. 

See GAO comment 2. 



(See figure in printed edition.)

See GAO comment 29. 

See GAO comment 31. 



(See figure in printed edition.)

See GAO comment 31. 



(See figure in printed edition.)

Now on pp.  33 and 41. 

Now on p.  42. 

Now on p.  42. 

See GAO comment 30. 

See GAO comment 35. 



(See figure in printed edition.)

See GAO comment 30. 

See GAO comment 36. 



(See figure in printed edition.)

See GAO comment 36. 



(See figure in printed edition.)

See GAO comment 36. 



(See figure in printed edition.)

See GAO comment 36. 

See GAO comment 33. 



(See figure in printed edition.)

See GAO comment 8. 



(See figure in printed edition.)

See GAO comments 8 and 36. 

See GAO comments 8 and 12. 

See GAO comments 8 and 36. 



(See figure in printed edition.)

See GAO comments 4, 7, 12, and 18. 



(See figure in printed edition.)

Now on p.  6. 

See GAO comment 14. 

Now on p.  24. 

See GAO comment 9. 

See GAO comment 9. 

Now on p.  31. 

See GAO comment 34. 



(See figure in printed edition.)

Now on p.  41. 

See GAO comment 30. 



(See figure in printed edition.)



(See figure in printed edition.)

Now on p.  49. 

See GAO comment 13. 

See GAO comment 13. 



(See figure in printed edition.)

See GAO comment 13. 


The following are GAO's comments on Crane's letter dated July 28,
1998. 


   GAO COMMENTS
--------------------------------------------------------- Appendix V:1

1.  Crane said that unlike in other industrialized countries, the
single source of the United States' currency paper has been selected
in an open and competitive process, for the most part, and that the
absence of multiple suppliers is not the absence of competition.  As
we point out in chapter 2, no firm other than Crane has submitted an
offer to BEP for the five solicitations covered in our review. 
Further, the paper manufacturers we surveyed identified several
factors that make it difficult for them to compete, including the
length of the currency paper contracts and the exclusion of
foreign-owned and controlled firms from supplying paper under the
Conte Amendment. 

2.  Crane said that (1) it has supplied paper at prices that are
significantly lower than prices paid by other G-7 nations to their
currency paper suppliers; (2) its currency paper prices have
decreased after it introduced new technology; (3) in real terms, its
prices for unthreaded and unwatermarked paper have declined between
1965 and 1995; and (4) historical comparisons of its prices and
comparisons of Crane's prices to currency paper prices of other
countries are more appropriate than comparisons to prices of other
types of paper, such as passport paper and money orders.  BEP was
unable to obtain prices paid by other countries, and Crane did not
provide us with any information substantiating the prices paid by
other countries when we requested it.  Later in its letter (page 8)
Crane states that Treasury had surveyed other countries and concluded
Crane's costs were lower.  We found no evidence to support this
statement.  However, we noted that in an unsolicited 1995 letter to
BEP, a foreign supplier offered currency paper to BEP at considerably
lower prices than Crane's contract prices. 

Crane said its inflation-adjusted prices for currency paper without a
thread and watermark and threaded currency papers were lower in 1995
than in 1965.  However, we note that the rate of inflation alone is
not a good indicator of the fairness and reasonableness of currency
paper prices because there is no evidence that the 1965 base price
was fair and reasonable.  In addition, Crane's prices for threaded
and watermarked currency paper were higher for contract 97-10 than
under contract 95-23.  Threaded and watermarked currency paper was
introduced under contract 95-23. 

Although we agree with Crane that historical comparisons of its
prices and comparisons of its prices to prices foreign countries pay
for currency paper would be useful, we also believe that comparisons
to other types of paper, such as passport paper and money order
paper, would provide useful information.  However, none of these
comparisons is likely to be definitive by itself.  For example,
according to BEP, the volumes of currency paper produced by the G-7
nations are considerably less than the volumes produced annually in
the United States, and this difference should be considered in any
price comparisons.  Furthermore, although price trend data provide
information that is helpful in assessing the fairness and
reasonableness of prices, they were not conclusive because it is not
known whether the base-year prices were fair and reasonable. 
Overall, we believe that competition, where several offers are
received, would provide the most objective means for determining
whether currency paper prices are fair and reasonable. 

3.  Crane disagreed with our recommendation to authorize the
Secretary of the Treasury to procure currency paper from a foreign
source if a fair and reasonable price cannot be obtained from a
domestic supplier and suggested that arbitration would be a better
alternative, given security issues associated with production in a
foreign country.  We disagree and believe that given the limited
number of suppliers of currency paper and BEP's weak negotiating
position, the government's interests would be better protected if BEP
had the option to obtain paper from another source until a domestic
source can be found that provides the paper at a fair and reasonable
price.  Although we fully recognize the security concerns associated
with production of currency paper outside the United States, our
recommendation is aimed at providing a temporary solution similar to
what Congress has provided for most federal agencies in general.  For
example, the Buy American Act, 41 U.S.C.  10a, which limits certain
purchases to items produced in the United States, also provides that
the limitations do not apply if the cost of the domestic item is
determined to be not reasonable.  Further, we believe the ability to
arrange for a foreign currency paper source would provide BEP with
needed leverage should it find itself in the same position it was in
during the period covered by our review, when it was unable to
determine that Crane's prices were fair and reasonable.  We did,
however, clarify the intent of our recommendation to recognize
Crane's issue regarding security. 

4.  Crane said the inhibitors to competition we identified in our
survey of manufacturers were no different from those identified by
BEP and incorporated into solicitation 97-13; thus, according to
Crane, BEP has already adopted our recommendations and it would be
premature to take further action until decisions are made on
solicitation 97-13.  This statement is incorrect.  Some factors,
including the 4-year contract length and the restriction against the
participation of foreign firms, are beyond BEP's control; they cannot
be adequately addressed in the solicitation unless Congress makes
legislative changes.  In addition, there are options beyond
willingness to accept "innovative" proposals for financial assistance
that could be considered. 

5.  Crane said we did not explain why the fundamental concepts of
fairness in federal procurement should be abandoned for the special
benefit of a few companies.  Our report does not suggest that
fairness be abandoned.  To the contrary, we suggested that fairness
to all interested competitors be ensured in the acquisition of
currency paper through the use of techniques that are provided for in
the procurement laws. 

The measures that we proposed in our draft report are authorized by
procurement statutes to address situations in which questions exist
as to product availability and/or whether prices paid by the
government in single-supplier situations are fair and reasonable. 
Further, providing CAP to a domestic supplier is authorized under the
FAR and could enable suppliers to overcome the high initial
investment impediment, but the value of the CAP would have to be
reflected in the evaluation of the offeror's price.  Reserving a
portion of the requirements to target opportunities for potential
alternative suppliers could allow another supplier some time to
achieve a production level that would determine whether the supplier
could produce quality currency paper at a competitive price. 
Moreover, given the special legislative provisions that apply to
currency paper production, it appears unlikely that potential
suppliers would be willing to enter the market without additional
action to encourage competition.  However, as we have discussed
previously, after considering the comments we received on our draft
report and reconsidering the uncertainties we identified in our
report, we deleted these two recommendations from our final report
but recognize that additional measures by Treasury to encourage
competition may be appropriate in the future. 

6.  Crane said that (1) it and BEP have usually been able to reach
agreement on prices, (2) independent analyses confirm that
agreed-upon prices have been fair, and (3) the report offers no
evidence that negotiated prices were anything but fair and
reasonable.  As pointed out in chapter 3, for the 17 contract actions
we reviewed, BEP and Crane were unable to reach agreement on 8, and
BEP was unable to determine whether the prices for 5 others were fair
and reasonable.  Crane did not furnish convincing data or analyses to
us in support of its view that the prices have been fair and
reasonable.  In any event, the determination of whether the prices
are fair and reasonable is to be made by BEP, and, as pointed out
above, it was unable to do so in several instances. 

7.  Crane said our report offers no facts or analysis to support the
conclusion that more effort is needed to encourage competition and
that the history recounted in our report demonstrates that BEP has
focused adequate attention on competition.  The report details how
BEP has not been successful in obtaining competition, discusses the
impediments to competition, demonstrates that BEP has not been in a
good position to protect the government's financial interests, and
provides options to encourage competition.  As the report points out,
Crane has supplied virtually all currency paper since 1879.  The
report notes BEP's efforts in recent years to obtain competition, as
well as the inhibitors that have affected its success; and the report
clearly points out that certain inhibitors were beyond BEP's control
and others were within its control.  Further, the report discusses
BEP's efforts in connection with its most recent solicitation and the
issues interested paper manufactures have raised. 

8.  Crane said the report fails to address the most important aspect
of the currency paper market, which is that the direct benefit to the
government of maintaining the quality and reliability of currency is
worth more than 200 times the cost of the paper itself.  We believe
the benefit Crane refers to is the interest earned by the Federal
Reserve on government securities that are held to back up the value
of currency issued.  We agree with Crane that the quality of U.S. 
currency paper is important.  However, we do not understand how this
benefit can be linked to the currency paper market.  Also, any firm
awarded a contract would be required to maintain the quality and
reliability of the paper used for currency. 

9.  Crane pointed out that our draft report incorrectly characterized
the start-up period in solicitation 97-13.  We have corrected this in
the report. 

10.  Crane, in referring to the arbitration settlement in which $12.7
million was returned to BEP, said that under a fixed-price contract,
such givebacks are not the norm.  We agree.  However, the normal
procedure under a fixed-price contract is to establish the price
before contract award; but in this instance, the parties were not
able to agree on prices for several years because the government
believed Crane's proposed prices were too high. 

11.  Crane said our report, in discussing the potential for
disruptions to the supply of currency paper, does not address the
importance of advanced anticounterfeiting technology in the paper
itself.  Chapter 1 of our report acknowledges that the use of more
sophisticated paper is one method of making U.S.  currency paper more
difficult to counterfeit.  Specifications for anticounterfeiting
features are included in BEP's solicitations, and any contracts that
are awarded must be performed in accordance with these requirements. 

12.  Crane said the report does not adequately define the optimum
circumstances for the procurement of currency paper and fails to
explain why perfect competition is deemed either unattainable or
undesirable by most large industrialized nations.  We do define
optimum circumstances in chapter 2 and also explain why competition
has not been obtained in the United States.  Although we attempted to
collect data from the other G-7 nations on how they procured banknote
paper, it was beyond our scope to explain the merits of the use of
single currency paper suppliers in those countries or to compare the
procurement processes of the United States with those of the other
G-7 nations.  Also, as BEP notes, the volume of currency production
in the other G-7 nations is less than in the United States; this
raises the question of whether there is sufficient volume of currency
paper production in other countries to support more than one
supplier. 

13.  Crane said the recommended options in our draft report to
provide financial assistance or exclude Crane from some or all of
BEP's requirements would be anticompetitive and would jeopardize the
currency supply by replacing Crane with an inexperienced supplier. 
Further, Crane said that the report offered no evidence that these
options would be effective and ignores the potential costs to the
government and risks associated with these options if they do not
work.  Also, Crane said that there is no relevant precedent for
taking these kinds of actions, and the report does not support the
use of the concept of dual sourcing for currency paper production. 
In fact, the options we suggested--offering financial assistance or
excluding Crane from being able to offer on some part of BEP's
requirements--are provided for in the procurement statutes and
regulations.  They are designed to enhance competition in the long
run, not lessen it.  Although we continue to believe that such types
of alternative strategies could be appropriate in the future, we
recognize that there are currently many uncertainties involved and
that Treasury may be in a better position in the future to consider
whether BEP should take additional measures to encourage competition. 

As our report says, DOD has taken steps to help establish a
competitive market in some instances in which it had concerns about
price and/or quality.  Although we agree with Crane that the products
involved in DOD's dual sourcing examples are certainly different from
currency paper, we believe that the dual sourcing concept is relevant
to currency paper as long as there is sufficient volume to
economically support multiple suppliers, and the interested paper
manufacturers we surveyed appear to believe a sufficient volume
exists.  Crane pointed out that according to a former Commander of
the Air Force's Systems Command, DOD uses this approach only when the
manufacturing process by a single source is inefficient and there are
clear opportunities to achieve technological breakthroughs by funding
another source.  However, the current Undersecretary of Defense for
Acquisition and Technology and DOD officials we interviewed said that
dual sourcing can yield significant improvements in quality and
reduction in cost in certain circumstances.  They said that this
result occurs because, in a sole source environment, there is very
little incentive for the producer to drive down cost, and the sole
source provider may have an incentive to raise costs because, in
subsequent years, price negotiations are based on the preceding
year's actual costs.  One DOD official we interviewed recognized that
dual sourcing may not work for currency paper but did not conclude
that the concept was inappropriate for consideration. 

Crane also raised other objections to our draft report's
recommendations to consider providing financial assistance and
excluding Crane from submitting an offer on some of BEP's
requirements.  For example, Crane said that our proposed
recommendations were based on our concern about possible disruptions
to the supply of currency paper and that we did not assess the
capability of potential suppliers to meet BEP's specifications.  We
did not base these proposed recommendations on a concern over a
supply disruption resulting from a security problem or a catastrophic
event, as Crane suggests.  Rather, they were based on the
difficulties of entering the currency paper market, concerns BEP had
over the fairness and reasonableness of Crane's prices over most of
the 10-year period covered by our review of BEP's procurement
records, questions that exist over Crane's profit levels in the
absence of a domestic market that could be used to assess the
fairness and reasonableness of Crane's prices, the difficulties BEP
encountered in reaching agreement with Crane over most of the 10-year
period, and BEP's lack of leverage in negotiations with Crane. 

As Crane notes, we did not independently assess the capability of
potential suppliers to meet BEP's requirements.  BEP is responsible
for making such an assessment in determining the responsibility of a
prospective contractor, and we did not propose that BEP award a
contract to a firm that could not meet its requirements. 

14.  Crane pointed out that our report incorrectly identified two
paper manufacturers with U.S.  addresses as being headquartered in
the United States.  We made this correction. 

15.  Crane said that BEP never offered financial assistance to it. 
However, we noted in the contract file for contract 97-10 that BEP
offered various financial incentives to Crane in an attempt to reduce
Crane's proposed profits and that Crane rejected these incentives. 

16.  Crane surmised that the substance of our survey to paper
manufacturers was derived from a letter sent to BEP by two of Crane's
potential competitors.  This letter asked BEP to lengthen its
contracts for currency paper, provide a split-quantity award, and
allow a longer start-up period.  Although we did not use this letter
as a basis for our survey, similar factors were identified by several
paper manufacturers who responded to our survey. 

17.  Crane said that obtaining best value should be the ultimate
objective in government procurement, not competition.  We agree. 
However, we continue to believe that when competitive procedures are
used and a market consisting of a number of responsible sources for
the government's needs exists, the expected result would be adequate
price competition so that an agency would be likely to obtain
supplies at a fair and reasonable price. 

18.  Crane believes that (1) our findings show that BEP's efforts to
promote competition have been adequate; (2) despite BEP's historical
use of full and open competition and special BEP efforts to develop
alternate sources, BEP's lack of success was due largely to Crane's
low prices and the other companies' inability to meet BEP's
requirements; and (3) our recommendations to Congress and BEP aimed
at enhancing competition are not necessary and would not be
beneficial.  As Crane notes, our report discusses BEP's efforts since
the 1960s to promote competition and the varied reasons for their
lack of success.  Also, as Crane notes, BEP cannot be faulted for
statutory restrictions, and our report clearly recognizes this. 
Because BEP did not have procurement records for contracts prior to
1988, we could not obtain detailed information on BEP's procurement
practices or efforts, its assessment of Crane's prices, or the extent
to which competition was sought prior to contract 88-205.  Thus, we
cannot provide additional insights on Crane's views of BEP's efforts
prior to 1988 other than what has already been discussed in our
report. 

On the other hand, the report identifies certain BEP practices in the
1980s and 1990s that may have inhibited competition.  These practices
included contracts with short performance periods and start-up
periods.  These were among the factors interested paper manufacturers
cited as inhibitors to competition.  The report also notes that BEP
addressed these as well as other issues in solicitation 97-13. 
Contrary to Crane's view, paper manufacturers we contacted cite the
statutory 4-year maximum currency paper contract length and the Conte
Amendment provisions as inhibitors to competition.  In fact, several
of the manufacturers said that they would be interested in submitting
offers if the contract term was extended and that they would not need
CAP if the term was more than 4 years. 

19.  Crane said that it is not clear that any significant benefit
would be achieved by extending the statutory 4-year limitation on
currency paper contracts.  In chapter 2, we point out that many
potential currency paper manufacturers disagree and said they would
be interested in submitting offers if the contract term was extended. 

20.  According to Crane, Portals decommissioned its Georgia mill in
1985 and sold it in 1986.  Officials from Portals and the company
that purchased the mill told us that the mill was sold in 1988, after
the Conte Amendment was enacted. 

21.  In replying to our statement that currency paper was easier to
produce before security threads and watermarks were introduced, Crane
questioned why other paper manufacturers either failed to meet the
technical requirements or decided they could not match Crane's
prices.  The manufacturers told us, as reported in chapter 2, that
certain provisions in BEP's solicitations prevented them from
competing, not the manufacturing process.  The paper manufacturers
did not identify Crane's prices as a factor that inhibited
competition.  Because BEP did not have procurement records for
contracts prior to 1988, we could not determine the effect, if any,
that the possibility of competition had on Crane's prices. 

22.  Crane said our report does not discuss how the government would
be protected if a subsidized contractor could not meet Crane's prices
or the government's requirements.  Crane pointed out that Portals
abandoned its Georgia plant in the 1980s because it could not meet
BEP's requirements and that Gilbert withdrew from the market because
it could not meet Crane's low prices.  Our draft report proposed that
BEP consider the feasibility of offering financial assistance and
that any actual use of assistance be predicated on it being
cost-effective.  Further, according to Portals officials, the company
abandoned its Georgia plant due to passage of the Conte Amendment. 

23.  Crane pointed out that the Mint's experience shows that open
procurements, not subsidies, are the best approach to encourage true
competition.  Although we did not study in detail the market for
clad-strip material, Mint officials told us that it is different from
the market for currency paper.  For example, the officials said that
clad material can be used for other products. 

24.  Crane said our report does not recognize the difficulties and
disadvantages associated with establishing a second source, such as
ensuring quality, increased research and development costs, and
ensuring that subsidized facilities are used in subsequent
procurements.  Crane also points out, as does our report, that in its
1996 currency paper study, Treasury concluded it would be more
economical to work with Crane than to develop a second source.  We
agree that our report does not discuss all of the advantages and
disadvantages of developing a second source; but any ultimate
decisions on whether to establish a second source should consider
these factors, as well as others, including the prices in contract
97-10.  The questions that exist regarding the fairness and
reasonableness of Crane's prices and the inhibitors that exist for
new suppliers to enter the currency paper market suggest to us that
additional exploration of the advantages and disadvantages of
establishing a second source could be beneficial in the future if BEP
does not get adequate competition otherwise and obtains more
information on relevant issues. 

25.  Crane said that when a contractor provides full disclosure of
its cost and prices, a government agency is not required to determine
that prices are fair and reasonable.  FAR 15.402 requires that
contracting officers purchase supplies and services from responsible
sources at fair and reasonable prices. 

26.  Crane said that under the FAR, either a cost or a price analysis
was a legitimate technique to determine a fair and reasonable price. 
This is not consistent with our understanding of the regulations. 
FAR 15.403-4 requires the contracting officer to obtain cost or
pricing data when adequate price competition is not achieved.  FAR
15.404-1 provides for both a cost and price analysis to be conducted
when cost or pricing data are submitted. 

27.  Crane said that the suggestion in our report that Crane took
advantage of BEP for the contracts covered by the arbitration
settlement does not fairly reflect the facts because Crane settled
for prices that were lower than Crane's proposed price estimates.  We
do not make such a suggestion in our report. 

28.  Crane disagreed with our observation that the government paid
for at least some of Crane's cost of developing the currency paper
with security thread.  We modified the report to show that Crane
proposed $2.4 million to develop the thread, which BEP accepted,
according to BEP contract records for contract 91-18.  The extent to
which additional costs for developing the thread may have been paid
for by BEP was not clear in BEP's contract records. 

29.  Crane said our report was incorrect in stating that Crane does
not periodically adjust its standard costs to reflect actual costs. 
We obtained this information from the 1994 DCAA post-award audit of
contract 88-205, option 1, which stated that the contractor submitted
inaccurate, incomplete, and noncurrent data for material cost.  This
was identified by DCAA as a systemic weakness because "the contractor
does not reconcile its standards and budgets with its actual cost
experienced." This systemic weakness was identified by DCAA as the
primary concern for about one-third of the $3 million overpricing on
this option.  We modified our report to show the specific contract
action affected by this adjustment problem. 

30.  Crane asked us to revise our description of a meeting that Crane
and BEP had regarding contract 95-23.  We did not make the change as
suggested by Crane because our sources for the statements were a
memorandum in BEP's files and statements we obtained from
representatives of Treasury and Crane who were at the meeting, and
Crane provided no evidence that these statements were inaccurate. 

31.  Crane commented that the arbitrator applied established
government guidelines to determine an appropriate level of profit
consistent with prevailing standards for a capital intensive industry
and made recommendations for settling contract pricing for the period
1992 through 1995.  In reviewing the decision, we noted that the
arbitrator did not cite a source for the "prevailing standards" for
return on investment.  Crane also cited other statements by the
arbitrator on the success of Crane's efforts to control costs.  We
note that these statements reflect the views of the arbitrator and
would not necessarily reflect the views of other independent parties
who would review the same issues. 

32.  Crane raised the possibility that it may be difficult for
multiple currency paper manufacturers to produce homogenous paper. 
BEP apparently does not share this concern as evidenced by
solicitation 97-13, which allows offers from multiple suppliers. 

33.  Crane said our report failed to consider that savings achieved
through competition for currency paper would be far exceeded by the
budgetary value of currency to the Treasury.  We agree, but we do not
believe this should be a factor in obtaining competition. 

34.  Crane said that a manufacturer's concern over providing
distinctive currency paper threads and watermarks has been addressed
by solicitation 97-13.  The report recognizes in chapter 2 that the
security thread will be provided by the government. 

35.  Citing our 1997 testimony on Coin and Currency Production: 
Issues for Congressional Consideration (GAO/T-GGD-97-146), Crane said
there were several low-impact options available to the government to
reduce risk of interruption to the supply of currency paper,
including stockpiling currency and reducing the destruction rate of
soiled notes.  Crane did not recognize that we were referring to
temporary alternatives to having a backup printing facility.  Crane
also did not mention, in its comments, that we also reported as other
alternatives reciprocal printing agreements with foreign countries
and arrangements with the private sector.  We pointed out in our
testimony that these latter two alternatives involved security
concerns because the Secret Service has no investigative authority
outside of the United States and that nongovernmental personnel and
facilities would be involved if a private sector printer were used. 
We concluded that issues such as these would have to be discussed
with Treasury before decisions on these matters were made. 

36.  Crane said that our discussion of the possible disruptions to
currency paper supplies ignored the threat of disruption due to
counterfeiting and that Crane's development of anticounterfeiting
features has assisted in the deterrence of widespread counterfeiting. 
Crane also said that the willingness of citizens and foreigners to
hold U.S.  currency provides $10 billion to $16 billion in annual
savings to the Treasury and that even a slight decline in the usage
of U.S.  currency resulting from doubts concerning authenticity, such
as lack of uniformity in the manufacturing of the paper, would result
in major financial loss to the government.  In both of these issues,
Crane appears to be implying that only one producer of currency paper
is capable of producing paper that has anticounterfeiting features
and that meets government standards.  We believe that Crane is not
the only currency paper manufacturer capable of producing
anticounterfeiting features or currency paper acceptable to the
public.  As pointed out in chapter 2, producers that say they have
this capability are located in foreign countries, but the Conte
Amendment has made it difficult for U.S.  firms to form joint
ventures with those firms that have the technological capability. 
Also, according to a Federal Reserve official, people throughout the
world use our currency because of our stable government, economy, and
superpower status, in spite of the fact that our currency continues
to be counterfeited, not because it is printed on paper produced by a
specific producer. 


MAJOR CONTRIBUTORS TO THIS REPORT
======================================================== Appendix VIII

GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C. 

John S.  Baldwin, Sr., Assistant Director
Tammy R.  Conquest, Assistant Director
Geraldine C.  Beard, Senior Evaluator
William R.  Chatlos, Senior Social Science Analyst
Stuart Kaufman, Senior Social Science Analyst

DALLAS FIELD OFFICE

Seth D.  Taylor, Senior Evaluator

OFFICE OF GENERAL COUNSEL,
WASHINGTON, D.C. 

John G.  Brosnan, Assistant General Counsel
Susan Michal-Smith, Senior Attorney

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