Defense Contracting: Contractor Claims for Legal Costs Associated with
Stockholder Lawsuits (Letter Report, 07/17/95, GAO/NSIAD-95-166).

Pursuant to a congressional request, GAO provided information on defense
procurement fraud cases focusing on the: (1) Defense Contract Audit
Agency's (DCAA) policy on the allowability of legal fees associated with
stockholder derivative lawsuits; and (2) number of stockholder lawsuits
associated with defense contractor wrongdoing.

GAO found that DCAA: (1) performs contract audit functions for the
Department of Defense (DOD) and audits costs and makes recommendations
regarding the allowability of costs claimed by contractors; (2) issued
audit guidance that addresses the allowability of legal fees incurred
when defending against stockholder derivative lawsuits; (3) concluded
that legal fees are unallowable when the lawsuit is based on contractor
wrongdoing. In addition, GAO found that: (1) there were 72 cases of
procurement fraud associated with DOD contractors from October 1988
through December 1994; (2) criminal fines, awards, and restitution
amounts totalled $1.03 billion; and (3) only 13 of the 72 cases involved
stockholder lawsuits.

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

 REPORTNUM:  NSIAD-95-166
     TITLE:  Defense Contracting: Contractor Claims for Legal Costs 
             Associated with Stockholder Lawsuits
      DATE:  07/17/95
   SUBJECT:  Defense audits
             Defense procurement
             Legal fees
             Litigation
             Department of Defense contractors
             Fraud
             Irregular procurement practices
             Criminal procedure
             Civil procedure
             Fines (penalties)

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


Report to the Ranking Minority Member, Committee on Commerce, House
of Representatives

July 1995

DEFENSE CONTRACTING - CONTRACTOR
CLAIMS FOR LEGAL COSTS ASSOCIATED
WITH STOCKHOLDER LAWSUITS

GAO/NSIAD-95-166

Defense Contracting


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

  DCAA - Defense Contract Audit Agency
  DOD - Department of Defense
  FAR - Federal Acquisition Regulation

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


B-258172

July 17, 1995

The Honorable John D.  Dingell
Ranking Minority Member
Committee on Commerce
House of Representatives

Dear Mr.  Dingell: 

This report responds to your inquiry concerning the allowability of
legal costs resulting from stockholder derivative lawsuits associated
with defense contractor wrongdoing.  As your letter indicates, the
wrongdoing involves fraudulent activities engaged in by the defense
contractor named in the stockholder lawsuit.  Specifically, you
requested current information on the (1) defense procurement fraud
cases, as previously reported on by us;\1 (2) Defense Contract Audit
Agency's (DCAA) policy on the allowability of legal fees associated
with stockholder derivative lawsuits; and (3) number of stockholder
lawsuits associated with defense contractor wrongdoing.  You also
asked whether reimbursement for these costs has been a common
practice. 


--------------------
\1 Defense Procurement Fraud:  Information on Plea Agreements and
Settlements (GAO/GGD-92-135FS, Sept.  17, 1992).  This fact sheet
contained information on cases the Department of Justice brought
against the companies that received large DOD contracts in 1991 that
resulted in criminal convictions or civil settlements or judgments. 


   BACKGROUND
------------------------------------------------------------ Letter :1

The Major Fraud Act of 1988 (P.L.  100-700) and the Federal
Acquisition Regulation (FAR) addresses the allowability of defense
contractors' legal fees and other proceeding costs related to
litigation with the federal government.  However, neither the act nor
the FAR expressly addresses the allowability of legal costs
associated with stockholder derivative lawsuits based on prior
corporate wrongdoing. 

DCAA performs contract audit functions for the Department of Defense
(DOD) and provides accounting and financial advisory services to DOD
components responsible for procurement and contract administration. 
In addition, DCAA audits costs and makes recommendations regarding
the allowability of costs claimed or proposed by contractors.  We
asked DCAA for its views on the legal costs you questioned. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

DCAA responded that, according to its research, the FAR contains no
cost principle dealing specifically with the allowability of legal
fees associated with defending against stockholder derivative
lawsuits.  However, its research concluded that such costs are
unallowable under the FAR cost principle on reasonableness of costs
(FAR 31.201-3) when the lawsuit is based on contractor wrongdoing. 
As a result, DCAA addressed this situation by issuing audit guidance,
on April 13, 1995, that now specifically deals with these costs.  The
guidance requires auditors to question costs incurred to defend
against stockholder lawsuits related to contractor wrongdoing.  (See
app.  I.)

From October 1988 through December 1994, there were 72 cases
involving procurement fraud--30 criminal and 42 civil--associated
with firms on DOD's Top 100 Contractor list.\2 Criminal fines,
awards, and restitution amounts approximated $1.03 billion.  (See
app.  II.)

It is not apparent that claiming reimbursement for stockholder
derivative legal costs is a common practice.  Of these 72 procurement
fraud cases, only 13 associated with 8 companies involved stockholder
lawsuits.  The legal costs of the stockholder lawsuits for the eight
companies totaled approximately $15 million; $6,232,150 was being
claimed under defense contracts by four of these contractors.  (See
app.  III.)


--------------------
\2 DOD maintains a list of the top 100 contractors with the largest
defense contracts based on dollar amount of their contracts.  DOD's
Office of the Inspector General, Criminal Division, semiannually
compiles a list of contractors, based on DOD's top 100 contractors
list, that were convicted of procurement fraud. 


   AGENCY COMMENTS
------------------------------------------------------------ Letter :3

DOD reviewed a draft of this report and concurred with its findings. 
(See app.  IV.)


   SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :4

We updated the list of defense procurement fraud cases through
information provided by (1) the DOD Inspector General's Criminal
Division, the Department of Justice, the Securities and Exchange
Commission, and DCAA and (2) a literature search.  This information
covered cases from October 1988 through December 1994. 

To develop a list of stockholder derivative lawsuits, we reviewed
those contractors on DOD's list of top 100 contractors that had
criminal procurement fraud convictions or had agreed to settlements
in civil actions for procurement fraud.  We established which of the
100 contractors had stockholder lawsuits and reviewed the legal costs
associated with these suits. 

Securities and Exchange Commission officials provided us with
quarterly and annual disclosure reports that corporations are
required to file.\3 These reports contained information pertinent to
stockholder litigation, if any, against the subject corporation.  We
also reviewed DCAA audit reports for the 10 contractors on our list
with the highest penalties to determine if DCAA had questioned the
allowability of costs associated with any related stockholder
lawsuits. 

Once our list was developed, we sent confirmation letters to 39
corporations in our universe to verify the stockholder lawsuits,
legal costs incurred, and amounts claimed for reimbursement.  We
received 31 responses that confirmed the number of stockholder
lawsuits already obtained from the other sources.  We did not
independently verify the information obtained from the contractors or
other sources.  We conducted our review from July 1994 through May
1995 in accordance with generally accepted government auditing
standards. 


--------------------
\3 These reports are known as 10Q Quarterly Report pursuant to
Section 13 or 15(d) of the Securities and Exchange Act of 1934 and
10K Annual Report pursuant to Section 13 or 15(d) of the Securities
and Exchange Act of 1934. 


---------------------------------------------------------- Letter :4.1

If you or your staff have any questions about this report, please
contact me on (202) 512-4587.  The major contributors were Charles
Rey, Assistant Director; Don Watson, Evaluator-in-Charge; and Jimmy
Palmer, Jr., Evaluator. 

Sincerely yours,

David E.  Cooper
Director, Acquisition Policy, Technology,
 and Competitiveness Issues


DEFENSE CONTRACT AUDIT AGENCY'S
POLICY ON THE ALLOWABILITY OF
CONTRACTOR CLAIMS FOR LEGAL COSTS
ASSOCIATED WITH STOCKHOLDER
LAWSUITS
=========================================================== Appendix I

On April 13, 1995, the Defense Contract Audit Agency (DCAA) responded
to our request for information on its policy regarding the
allowability of legal costs associated with stockholder derivative
lawsuits based on prior litigation with the government.  DCAA
researched the allowability of these costs and determined that there
was no Federal Acquisition Regulation (FAR) cost principle dealing
specifically with them.  However, because DCAA determined that they
are unallowable under the FAR cost principle for determining
reasonableness, DCAA issued the enclosed audit guidance memorandum. 



(See figure in printed edition.)



(See figure in printed edition.)



(See figure in printed edition.)


CRIMINAL AND CIVIL PROCUREMENT
FRAUD CASES INVOLVING TOP 100 DOD
CONTRACTORS, OCTOBER 1988 THROUGH
DECEMBER 1994
========================================================== Appendix II



                                    Table II.1
                     
                     Criminal Procurement Fraud Dispositions

                                 Case
Case       Contracto             dispositi    Date of      Criminal
number     r          Case type  on         conviction         fine  Restitution
---------  ---------  ---------  ---------  -----------  ----------  -----------
1          Bicoastal  Procureme  Pled        11/04/93    $1,000,000  $55,600,000
           Corporati  nt and     guilty
           on         mail
                      fraud

2          Boeing     Procureme  Pled        11/13/89        20,000    4,000,000
           Company    nt fraud   guilty

3          E Systems  Procureme  Pled        10/02/90     2,000,000    1,800,000
                      nt         guilty
                      fraud

4          Emerson    Procureme  Pled         5/11/90        40,000    9,000,000
           Electric   nt fraud   guilty
           Company

5          Exxon      Procureme  Pled        11/10/93     3,801,875         None
           Chemical   nt fraud   guilty
           Company

6          Fairchild  Procureme  Pled         5/11/90     2,950,000         None
           Industrie  nt fraud   guilty
           s
           Incorpora
           ted

7          General    Procureme  Pled         7/22/92    69,000,000         None
           Electric   nt fraud   guilty
           Company

8          General    Procureme  Found        2/02/90    10,000,000    2,200,000
           Electric   nt and     guilty
           Company    mail
                      fraud

9          General    Procureme  Found        3/07/94     9,500,000   69,500,000
           Electric   nt and     guilty
           Aircraft   mail
           Engines    fraud

10         Grumman    Procureme  Pled         3/16/90        20,000         None
           Corporati  nt fraud   guilty
           on

11         GTE        Procureme  Pled         2/03/89        20,000         None
           Governmen  nt fraud   guilty
           t
           Systems
           Corporati
           on

12         Harris     Kickback   Pled no      7/02/89       200,000         None
           Corporati             contest
           on

13         Hazeltine  Procureme  Pled         1/06/89     1,000,000         None
           Corporati  nt fraud   guilty
           on
           (subsidia
           ry of
           Emerson
           Electric
           Company)

14         Hughes     Procureme  Found        6/15/92     3,500,000        \None
           Aircraft   nt fraud   guilty
           Company
           (subsidia
           ry of
           General
           Motors
           Corporati
           on)

15         Hughes     Procureme  Pled         3/09/90        20,000         None
           Aircraft   nt fraud   guilty
           Company
           (subsidia
           ry of
           General
           Motors
           Corporati
           on)

16         Ladish     Procureme  Pled        11/09/92       751,600         None
           Company    nt fraud   guilty

17         Litton     Procureme  Pled         1/14/94     3,900,000         None
           Systems,   nt fraud   guilty
           Incorpora
           ted

18         Loral      Procureme  Pled        12/08/89     1,500,000         None
           Corporati  nt fraud   guilty
           on

19         LTV        Procureme  Pled         8/14/90        10,000         None
           Aerospace  nt fraud   guilty
           and
           Defense
           Company

20         Magnavox   Procureme  Pled         9/17/90       150,000         None
           Governmen  nt fraud   guilty
           t
           and
           Industria
           l
           Electroni
           cs
           Company

21         Northrop   Procureme  Pled         2/27/90    17,000,000         None
           Corporati  nt fraud   guilty
           on

22         Raytheon   Procureme  Pled         3/20/90        10,000         None
           Corporati  nt fraud   guilty
           on

23         RCA        Procureme  Pled         2/05/90        20,000         None
           Corporati  nt fraud   guilty
           on
           (subsidia
           ry of
           General
           Electric)

24         Rockwell   Procureme  Pled         1/19/89     5,500,000      446,000
           Internati  nt fraud   guilty
           onal
           Corporati
           on

25         Science    Procureme  Pled         8/26/91       550,000         None
           Applicati  nt fraud   guilty
           ons
           Internati
           onal

26         Sundstran  Procureme  Pled        10/19/88       500,000         None
           d          nt fraud   guilty
           Corporati
           on

27         Sundstran  Procureme  Pled        10/21/88    115,000,00         None
           d          nt fraud   guilty                           0
           Corporati
           on

28         Teledyne   Procureme  Pled        10/02/92    17,500,000         None
           Incorpora  nt fraud   guilty
           ted

29         Teledyne   Procureme  Pled         3/23/89     1,500,000         None
           Incorpora  nt fraud   guilty
           ted

30         Unisys     Procureme  Pled         9/06/91     4,000,000         None
           Corporati  nt fraud   guilty
           on

================================================================================
Total                                                    $270,963,4  $142,546,00
                                                                 75            0
--------------------------------------------------------------------------------
Sources:  This listing is derived from data provided by the DOD
Inspector General and the Department of Justice.  Additionally,
information addressing this subject was contained in our September
1992 report.. 



                                    Table II.2
                     
                       Civil Procurement Fraud Settlements

                                                             Date of    Award to
                                          Case            dispositio         the
Case number   Contractor    Type case     disposition              n  government
------------  ------------  ------------  --------------  ----------  ----------
1             Argosystem    Voluntary     \a                      \a  $3,000,000
              Incorporated  disclosure
              (subsidiary   fraud
              of Boeing
              Company)

2             Argosystem    False Claims  Settled           12/23/92     868,000
              Incorporated  Act           without
              (subsidiary                 litigation
              of Boeing
              Company)

3             AT&T Company  Procurement   Settled            9/12/90     625,000
                            fraud         without
                                          litigation

4             Avondale      Procurement   Settled           10/10/89   2,500,000
              Industries,   fraud         without
              Incorporated                litigation

5             Boeing        False Claims  Settled            4/29/94  75,000,000
              Company       Act           without
                                          litigation

6             Boeing        False Claims  Settled            4/15/94     250,000
              Company       Act           without
                                          litigation

7             CAE Link &    False Claims  Settled               9/92  55,500,000
              Singer        Act           without
              Company                     litigation

8             Computer      Procurement   Settled           10/09/90   1,750,000
              Sciences      fraud         without
              Corporation                 litigation

9             Ex Cell O     Procurement   Settled            8/20/90      91,000
              Corporation   fraud         without
              (subsidiary                 litigation
              of Textron)

10            Ex Cell O     Procurement   Settled            9/20/90   3,650,000
              Corporation   fraud         without
              (subsidiary                 litigation
              of Textron)

11            Federal       False Claims  Settled            8/21/92     950,000
              Express       Act           without
                                          litigation

12            Ford          Procurement   Settled           10/06/89     200,000
              Aerospace &   fraud         without
              Communicatio                litigation
              ns
              Corporation

13            Ford          Procurement   Settled            8/10/90     119,250
              Aerospace &   fraud         without
              Communicatio                litigation
              ns
              Corporation

14            Ford          Voluntary     Settled            8/10/90     111,300
              Aerospace &   disclosure    without
              Communicatio  fraud         litigation
              ns
              Corporation

15            Ford Motor    Procurement   Multiple           8/10/90   2,606,063
              Company       fraud         disposition

16            General       Procurement   Settled           11/21/88   2,600,000
              Dynamics      fraud         without
              Corporation                 litigation

17            General       Procurement   Postfiling        12/20/91   8,000,000
              Dynamics      fraud         settlement
              Corporation

18            Honeywell,    Voluntary     Settled            1/03/91     700,000
              Incorporated  disclosure    without
                            fraud         litigation

19            Litton        False Claims  Settled            7/14/94  82,000,000
              Systems,      Act           without
              Incorporated                litigation

20            Litton        Procurement   Settled            5/06/91   2,400,000
              Systems,      fraud         without
              Incorporated                litigation

21            Litton        False Claims  Settled            1/14/94   2,400,000
              Systems,      Act           without
              Incorporated                litigation

22            Lockheed      False Claims  Settled            8/04/92   1,042,144
              Corporation   Act           without
                                          litigation

23            Lockheed      False Claims  Settled            4/30/93     639,641
              Corporation   Act           without
                                          litigation

24            Martin        Procurement   Settled            4/22/92     752,000
              Marietta      fraud         without
              Corporation                 litigation

25            McDonnell     Qui tam\b     Postfiling         8/29/89      28,000
              Douglas                     settlement
              Corporation

26            McDonnell     Procurement   Settled            3/13/91   1,100,000
              Aircraft      fraud         without
              Company                     litigation

27            Olin          Voluntary     Settled            5/17/91     694,586
              Corporation   disclosure    without
                            fraud         litigation

28            Olin          False Claims  Settled            9/13/93     325,000
              Corporation   Act           without
                                          litigation

29            Texas         Voluntary     \a                      \a     230,750
              Instruments,  disclosure
              Incorporated  fraud

30            Texas         False Claims  Settled            8/05/94   5,000,000
              Instruments,  Act           without
              Incorporated                litigation

31            Texas         False Claims  Settled            8/26/92      36,526
              Instruments,  Act           without
              Incorporated                litigation

32            Texas         False Claims  Settled            8/25/92     550,000
              Instruments,  Act           without
              Incorporated                litigation

33            Tracor        Defective     Settled            8/15/91     450,000
              Corporation   pricing       without
                                          litigation

34            TRW,          False Claims  Settled            6/28/93   2,500,000
              Incorporated  Act           without
                                          litigation

35            TRW,          False Claims  Settled            4/15/94  29,000,000
              Incorporated  Act           without
                                          litigation

36            Unisys        Qui tam\b     Postfiling         9/06/91   8,200,000
              Corporation                 settlement

37            Unisys        Qui tam\b     Postfiling         9/06/91   3,200,000
              Corporation                 settlement

38            Unisys        Bribery,      Settled            9/06/91  159,000,00
              Corporation   conflict of   without                              0
                            interest and  litigation
                            kickback

39            United        False Claims  Settled            3/30/94  150,502,93
              Technologies  Act           without                              1
                                          litigation

40            United        False Claims  Settled            8/28/92   4,000,000
              Technologies  Act           without
                                          litigation

41            Varian        Procurement   Settled           12/13/88   2,430,000
              Associates,   fraud         without
              Incorporated                litigation

42            Westinghouse  Procurement   Settled            7/07/91     665,000
              Electric      fraud         without
              Corporation                 litigation

================================================================================
Total                                                                 $615,667,1
                                                                              91
--------------------------------------------------------------------------------
\a The Department of Justice has won one or more awards and is
pursuing further relief in the case. 

\b A qui tam action is one in which a private party brings suit in
the name of the United States and is entitled to a portion of the
proceeds if the prosecution is successful. 

Sources:  Data obtained from the DOD Inspector General and the
Department of Justice.  Other information addressing this subject was
contained in our September 1992 report. 


CONTRACTORS WITH STOCKHOLDER
DERIVATIVE LAWSUITS AND ASSOCIATED
COSTS
========================================================= Appendix III

Data in this appendix were obtained from contractor confirmation
letters, DCAA responses to our requests for information, and
Securities and Exchange Commission reports.  To protect the
potentially proprietary nature of the data, we have replaced the
names of affected companies with alphabetic labels (A-H). 

