Defense Procurement: E-Systems' Reporting of Alleged Wrongdoing to Army's
Fraud Division (Letter Report, 05/16/96, GAO/OSI-96-6).

Pursuant to a congressional request, GAO reviewed a defense contractor's
reporting of alleged wrongdoing to the Army's fraud division, focusing
on: (1) whether federal laws, regulations, or its administrative
settlement agreement required the contractor to disclose suspected
violations of procurement law; (2) how many and what types of hotline
violations were lodged against the contractor; (3) whether contractor
employees altered or reinvestigated hotline complaints to avoid
disclosure to the government; (4) the details of three specific hotline
cases; (5) why the Army failed to debar the contractor from further
government business after the serious allegations that resulted in a May
1994 show-cause letter; and (6) what loss the government sustained as a
result of the contractor's actions.

GAO found that: (1) the contractor's two administrative agreements and
its own business ethics standards required it to report suspected
procurement law violations to the Army's fraud division; (2) the
contractor did not fully detail allegations in its Army reports under
its settlement agreement or report 39 pre-agreement cases or 16 cases
that occurred between the two agreements; (3) all of the 202 hotline
complaints from August 1990 through August 1993 were reported to the
Army; (4) 41 percent of the cases involved alleged federal contract
violations and the rest involved management and employee relations
issues; (5) from July 1994 through November 1994, the contractor
reported three hotline cases, one of which involved procurement law
violations; (6) in three specific cases, the contractor did not report
its findings or all relevant information to the Army; (7) there was no
evidence that the contractor altered internal investigation reports or
reinvestigated hotline complaints to avoid disclosure to the government;
(8) although the Defense Logistics Agency found that the contractor
violated the agreement, it did not debar the firm because there was
insufficient evidence to prove that it intentionally withheld
information from the government; (9) the contractor's second
administrative settlement agreement requires it to provide the Army with
more details of allegations and resolutions than did the first
agreement; and (10) the government sustained a potential loss of about
$228,000 in one case involving time mischarging and an unknown amount in
a case involving parts scrapping.

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

 REPORTNUM:  OSI-96-6
     TITLE:  Defense Procurement: E-Systems' Reporting of Alleged 
             Wrongdoing to Army's Fraud Division
      DATE:  05/16/96
   SUBJECT:  Ethical conduct
             Army procurement
             Contract violations
             Administrative remedies
             Procurement regulation
             Contract noncompliance
             Investigations by federal agencies
             Information disclosure
             Telephone communications operations
             Department of Defense contractors
IDENTIFIER:  Defense Industry Initiative on Business Ethics
             
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Cover
================================================================ COVER


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

May 1996

DEFENSE PROCUREMENT - E-SYSTEMS'
REPORTING OF ALLEGED WRONGDOING TO
ARMY'S FRAUD DIVISION

GAO/OSI-96-6

E-Systems' Reporting of Allegations to the Army

(600359)


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

  AFOSI - Air Force Office of Special Investigations
  DCAA - Defense Contract Audit Agency
  DII - Defense Industry Initiative on Business Ethics and Conduct
  DLA - Defense Logistics Agency
  GAO - General Accounting Office
  OIG - Office of Inspector General
  OSI - Office of Special Investigations

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


B-265783

May 16, 1996

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

Dear Mr.  Dingell: 

After E-Systems, Inc., a defense contractor, pleaded guilty in July
1990 to violations of federal law related to contracts with the
Department of the Army, the Army entered into a 3-year administrative
settlement agreement (Memcor Agreement) with the company.  Among
other things, the agreement required E-Systems to report all
hotline\1

allegations to the Army's Procurement Fraud Division.  When the
Subcommittee on Oversight and Investigations, House Committee on
Energy and Commerce, received allegations from a former chief
investigator for E-Systems' Greenville (Texas) Division concerning
the division's hotline/ethics program, you, as the Subcommittee's
then Chairman, asked us to answer the following questions. 

  -- Did federal law, regulations, or the Memcor Agreement require
     E-Systems to disclose suspected violations of procurement law? 

  -- How many and what types of hotline complaints were lodged
     against E-Systems' Greenville Division? 

  -- Did E-Systems' employees, contrary to federal law, alter or
     reinvestigate hotline complaints and investigation results to
     avoid disclosing information to the federal government; and what
     were the details behind three cases that had been brought to the
     Subcommittee's attention? 

  -- Why did the Army not debar E-Systems from doing business with
     the government, given the serious accusations contained in a May
     1994 Army "show cause" letter? 

  -- What loss did the government experience as a result of
     E-Systems' actions in the three previously mentioned hotline
     cases? 


--------------------
\1 Under the Defense Industry Initiative on Business Ethics and
Conduct, E-Systems established a hotline in June 1987. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :1

Although federal laws and regulations did not require E-Systems to
report suspected violations of procurement law to the government, the
August 1990 Memcor Agreement, and a later second administrative
agreement, required the company to do so, as did its Standards of
Business Conduct and Ethics. 

During the period covered by the Memcor Agreement (Aug.  1990-Aug. 
1993), E-Systems' Greenville Division reported that 202 cases
regarding hotline complaints had been opened or closed.  All were
reported to the Army's Procurement Fraud Division.  Of the 202 cases,
83 (about 41 percent) related to alleged wrongdoing in federal
contracts; the rest, management and employee-relations issues.  From
the start of a second administrative agreement in July 1994 through
November 1994, the latest date covered by our investigation,
E-Systems opened and reported three hotline cases; one dealt with
procurement law violations. 

In its quarterly reports to the Army, required by the Memcor
Agreement, E-Systems did not report the findings of wrongdoing for
one of the three hotline cases that were the focus of the allegations
to the Subcommittee.  The E-Systems reports included inaccurate
information or omitted relevant facts about the other two cases. 
Information about these wrongdoings--including making false claims
and falsifying documents--was contained in the hotline investigator's
reports.  The Defense Logistics Agency (DLA), in its 1994 review of
E-Systems' compliance with the Memcor Agreement, generally concurred
with the hotline investigator's reports.  We found no evidence that
E-Systems had altered internal investigation reports or
reinvestigated hotline complaints to avoid disclosing information to
the federal government. 

Following that 1994 review, DLA reported that E-Systems had violated
the Memcor Agreement.  However, E-Systems' violations did not merit
debarment,\2 according to the Chief, Army's Procurement Fraud
Division, because the Army did not have sufficient evidence to prove
that E-Systems had intentionally withheld information from the
government.  Nevertheless, in July 1994, the Army entered into a
second administrative settlement agreement that required E-Systems'
reports to the Army to provide more detailed information about each
allegation and its resolution than did the first agreement. 

A potential loss to the government occurred in at least one of the
three hotline cases that we examined.  The Defense Contract Audit
Agency (DCAA) estimated that E-Systems' actions may have cost the
government about $228,000, resulting from mischarged labor hours. 


--------------------
\2 "Debarment" is excluding a contractor from government contracting
for a reasonable, specified period of time, generally not to exceed 3
years.  FAR 9.406-4(a).  "Suspension" is temporarily disqualifying a
contractor from government contracting for up to 18 months unless
legal proceedings are initiated during that period.  FAR 9.407-4.  A
contractor found guilty of violating procurement law or an
administrative settlement agreement faces possible suspension or
debarment action. 


   BACKGROUND
------------------------------------------------------------ Letter :2

As a result of numerous reports of questionable procurement practices
by defense contractors, in 1986 the President's Blue Ribbon
Commission on Defense Management (Packard Commission) recommended
contractor self-regulation to strengthen accountability in lieu of
increased federal legislation and oversight.  To implement the
recommendation, a number of Department of Defense contractors adopted
the Defense Industry Initiative on Business Ethics and Conduct (DII). 

Under DII, signatories commit to a written code of business ethics
and conduct, create a free and open atmosphere that encourages
employees to report violations to the company without fear of
retribution, and monitor compliance with federal procurement law. 
They also commit to voluntarily report procurement violations and
corrective actions to the appropriate federal agency.  In a July 1986
letter, the Deputy Secretary of Defense encouraged all defense
contractors to report potential criminal matters to the Deputy
Inspector General, Department of Defense, and report potential
noncriminal matters to DCAA or the appropriate contracting officer. 
Since DII is a voluntary disclosure program, federal agencies cannot
initiate enforcement action for noncompliance with DII's principles. 

On July 3, 1986, E-Systems signed DII--one of the first companies to
do so.  To comply with DII, each E-Systems division, including the
Greenville Division, established an Ethics Hotline for employees to
report suspected violations of federal procurement law, an Ethics
Program Director to direct internal investigations of hotline cases,
and a senior-level management Ethics Committee. 

After E-Systems pleaded guilty in July 1990 to three counts of false
claims and conspiracy committed by its Memcor Division in Bushnell,
Florida, (1) E-Systems provided the Army a compliance plan to ensure
that failures to comply with federal procurement law would not recur;
and (2) the Army, in August 1990, entered into a 3-year
administrative settlement agreement with E-Systems (Memcor
Agreement).  The agreement, which included the compliance plan,
required E-Systems to report all hotline allegations and their
resolution to the Army's Procurement Fraud Division. 


   E-SYSTEMS DID NOT ABIDE BY ITS
   OWN REQUIREMENT TO REPORT
   SUSPECTED VIOLATIONS AND DID
   NOT FULLY DETAIL VIOLATIONS
   UNDER THE MEMCOR AGREEMENT
------------------------------------------------------------ Letter :3


      E-SYSTEMS' OWN REPORTING
      REQUIREMENTS NOT FOLLOWED
---------------------------------------------------------- Letter :3.1

Federal law and regulations did not require E-Systems to report
suspected violations of procurement law to the government.  However,
as a DII signatory, E-Systems has committed--but is not required--to
implement six principles of business ethics and conduct, including
those that relate to the disclosure of procurement law violations to
the federal government.  Although E-Systems' own Standards of
Business Conduct and Ethics required the company to report suspected
violations to the appropriate government agencies, E-Systems did not
begin to formally report suspected violations to the government until
required to do so in August 1990 by the Memcor Agreement. 

E-Systems officials told us that "where issues of potential
significance were identified, notification to the government did
occur" outside the timeframes of the Memcor and second administrative
agreements.  However, the experiences of the government agencies that
should have received such reports differed.  E-Systems' lack of
disclosure was evidenced by a DCAA audit report and the experiences
of DCAA representatives, the Defense Plant Representative Office,\3
and the Department of Defense Office of Inspector General (OIG). 


--------------------
\3 E-Systems specifically identified a former Commander of the
Defense Plant Representative Office who, according to E-Systems, had
been briefed on November 1, 1988, on a hotline case.  Although the
Defense Plant Representative Office has no record of the issue, the
former Commander told us he recalls the issue but not its details. 
According to the former Commander, he trusted E-Systems to protect
the government's interests in such cases.  He said that because he
had been at E-Systems only a month on November 1, his former Deputy
and Chief of the Contracts Division would have been included in any
formal meeting with E-Systems and would be the best source for
follow-up action on the issue.  However, that individual told us that
he had not been made aware of the allegation, as such an issue would
normally have been referred for further inquiry to the Defense
Investigative Service (now the Defense Criminal Investigative
Service) or to the Department's legal department. 


      ALLEGED VIOLATIONS NOT FULLY
      DETAILED IN E-SYSTEMS'
      REPORTS UNDER MEMCOR
      AGREEMENT
---------------------------------------------------------- Letter :3.2

Although the Memcor Agreement required E-Systems to provide the Army
quarterly reports of all hotline cases and their resolution, the
agreement did not specify the level of detail that E-Systems should
use in the reports.  The Army agreed that E-Systems would provide it
with copies of quarterly reports made to the company's Audit
Committee.  According to E-Systems' compliance policies, these
reports to the Audit Committee would ensure "a high level of review
and oversight." The reports did not, however, contain the level of
detail that the Army had expected. 

For example, an April 1994 DLA compliance review concluded that
E-Systems' quarterly reports "did not always depict the allegations
accurately" and did not "necessarily depict the findings of the
investigator." The Army concurred with DLA's findings and in July
1994 entered into a 2-year administrative agreement with E-Systems. 
This second agreement required E-Systems to modify its quarterly
reports so that the Army would receive a copy of the hotline
allegations, the status of the investigation, and the investigation's
findings and conclusions. 


   NUMBER AND TYPES OF HOTLINE
   COMPLAINTS
------------------------------------------------------------ Letter :4

As a result of signing DII, E-Systems established an Ethics Hotline
in each of its divisions so that its employees could report suspected
violations.  In June 1987, the Greenville Division received its first
hotline call.  From that time until November 1994 (the latest date
covered by our investigation), E-Systems' hotline log showed that it
had opened cases for 260 complaints.  The division delineated the
allegations into six categories:  (1) improper time charging; (2)
improper work, parts, and procedures; (3) conflict of interest/vendor
issues; (4) safety, security, and drugs; (5) personnel; and (6)
other.  Of the 260 cases, 106 related to allegations of procurement
violations and 154 to management and employee-relations issues.  (See
table 1.)



                                Table 1
                
                E-Systems/Greenville Division's Hotline
                             Calls Received

                                        Alleged    Management/   Total
                                     procuremen       employee  hotlin
                                              t      relations       e
Hotline time frame                   violations         issues   calls
-----------------------------------  ----------  -------------  ------
June 1987 -
 August 1990\a                               17             22      39
August 1990 -
 August 1993
 (Memcor Agreement)                          83            119     202
August 1993 -
 July 1994\b                                  5             11      16
July 1994 -
 November 1994\c                              1              2       3
Total                                       106            154     260
----------------------------------------------------------------------
\a Period from hotline inception until beginning of Memcor Agreement. 

\b Period between Memcor Agreement and second administrative
agreement. 

\c Period from beginning of second administrative agreement through
the latest data received. 

The 202 hotline cases opened during the period covered by the Memcor
Agreement were reported to the Army's Procurement Fraud Division. 
According to a DCAA audit report as well as representatives of DCAA,
the Defense Plant Representative Office, and the Defense OIG,
E-Systems, counter to its standards of ethics and DII, did not report
to the federal government any of the 39 cases opened prior to the
Memcor Agreement.  E-Systems also did not report to the federal
government any of the 16 cases it opened during the period between
when the Memcor Agreement had expired and the second administrative
agreement took effect. 

E-Systems did report the three cases it received from the beginning
of the second administrative agreement through November 1994. 


   COMPLAINTS NOT ALTERED BUT
   REPORTS DID NOT FULLY DISCLOSE
   INVESTIGATIVE FINDINGS IN THREE
   CASES
------------------------------------------------------------ Letter :5

None of the information that we examined indicated that E-Systems had
altered the hotline reports, or reinvestigated the cases, prepared by
the hotline investigator for cases 66, 114S, and 226--the subjects of
concern to the Subcommittee--to avoid disclosing information to the
government.  However, E-Systems' quarterly reports to the Army did
not completely or accurately disclose the hotline investigators'
findings in the three cases.  The findings in one case were not
disclosed at all, while in the two remaining cases, the reported
findings did not reflect those developed by the hotline investigator. 
E-Systems' reports showed that no wrongdoing had occurred even though
the investigator reported that he substantiated that it had.  DLA
later concurred with most of his findings. 

According to the former chief investigator for E-Systems' Greenville
Division, he had substantiated almost all of the allegations in the
three cases.  They included allegations of document falsification,
false statements, and violations of company policies.  Nevertheless,
the quarterly reports that E-Systems sent to the Army did not include
such information. 

Regarding the completeness of the quarterly reports, E-Systems'
outside counsel said the company's practice was to include all of the
allegations of a hotline case in the quarterly report that closed the
case.  However, only case 114S appeared in a quarterly report (Mar. 
1992) to the Army when it was closed.  According to an E-Systems
representative, the company inadvertently omitted case 66 (closed in
Jan.  1992); and case 226 was not reported because it was closed in
December 1993, after the Memcor Agreement had expired and before the
second administrative agreement had been implemented.  E-Systems did
provide the Army a copy of the quarterly report that contained
closing information about case 226, after the Army requested that it
do so as a result of the DLA compliance review of E-Systems. 
However, that quarterly report did not contain all of the allegations
received.  Instead, the quarterly report stated, in part, "During the
investigation the caller made five other allegations.  Of the five
only one required corrective action.  .  .  ." The report provided
details about only the one allegation for which E-Systems required
correction. 

In a June 28, 1994, letter to the Army's Procurement Fraud Division,
E-Systems' outside counsel stated that case 226 had been reported to
DCAA and the Defense Plant Representative Office during a meeting. 
We confirmed that E-Systems had discussed case 226 with government
representatives--1 month after E-Systems had been notified of an
impending DLA compliance review of the Memcor Agreement. 

Further, E-Systems' summary reports on two (66 and 114S) of the three
cases--prepared for the Air Force Office of Special Investigations
(AFOSI), the Defense Criminal Investigative Service, and an Assistant
U.S.  Attorney during an investigation of E-Systems--also did not
indicate any wrongdoing.  Yet, a 1994 DLA report generally concurred
with the hotline investigator's findings of wrongdoing and noted that
E-Systems should have fully disclosed these findings to the federal
government.  With regard to all three cases, the DLA compliance
review of the Memcor Agreement indicated that E-Systems should have
involved the government in the hotline investigations and should have
disclosed suspected wrongdoing to the government.  (App.  I, II, and
III discuss the three cases.)


   NO DEBARMENT BUT MORE DETAILED
   REPORTING REQUIRED
------------------------------------------------------------ Letter :6

In April 1994, following DLA's compliance review of the Memcor
Agreement, DLA reported that E-Systems had violated that agreement by
(1) restricting the agency's access to hotline files and other
supporting documents and (2) not submitting accurate reports of fraud
and ethical violations.  The report continued that E-Systems' actions
during the review appeared "to run counter to the spirit and letter
of the Memcor Agreement, DII principles and contractor integrity." As
a result of these findings, on May 26, 1994, the Army's Procurement
Fraud Division required E-Systems to show cause, or justify, why it
should not be suspended or debarred for violating the Memcor
Agreement. 

On the basis of E-Systems' response and a meeting with company
officials, according to the Chief, Remedies Branch, Army Procurement
Fraud Division, the Army determined that it did not have sufficient
evidence to prove that E-Systems had intentionally withheld
information from the government.  Nevertheless, to ensure that
E-Systems provided the Army sufficient information to assess the
company's hotline/ethics program, the Army negotiated a 2-year
administrative agreement with E-Systems in July 1994. 

Under the 1994 agreement, E-Systems was required to provide greater
details in its quarterly reports to the Army.  According to the
Chief, as of November 1995 E-Systems had provided the information
required under the second agreement.  Our review of the first
quarterly report submitted under the second agreement confirmed that
E-Systems had provided the agreed-upon information--nature of hotline
allegations, status of investigations, and their resolution. 


   POTENTIAL LOSS TO THE
   GOVERNMENT
------------------------------------------------------------ Letter :7

The government experienced a potential loss as a result of E-Systems'
actions pertaining to hotline case 226.  According to DCAA and AFOSI,
E-Systems employees mischarged their time on case 226 to overhead
instead of to bid-and-proposal costs.\4 E-Systems performed an
internal audit of the charging and, according to an E-Systems
official, credited approximately $33,000 to the government.  However,
according to DCAA and AFOSI, E-Systems' mischarging also affected
labor rates charged to subsequent government contracts and may have
resulted in "harm" to the federal government of about $228,000.  As a
result, AFOSI and DLA referred the issue to the Defense Plant
Representative Office at E-Systems' Greenville Division for audit. 
As of April 1996, according to a DLA official, the resolution of this
issue was still in process. 

Further, in case 66 we determined, on the basis of information
provided to us by DCAA, that E-Systems had scrapped purchased parts\5
having a replacement value of about $92,000.  The government later
repurchased, through contracts with E-Systems, many of the same type
of parts at a cost of over $57,000.  We were unable to determine what
loss to the government, if any, this constituted because necessary
documentation was unavailable. 


--------------------
\4 Costs allocable to only one government contract are direct costs
of that contract and are to be charged directly to the contract.  FAR
31.202(a).  Direct costs of a specific contract requirement or an
element of a specific contract's performance cannot properly be
allocated as indirect costs. 

\5 According to DCAA representatives, purchased parts are parts that
E-Systems has purchased from other contractors and then resold to the
government. 


---------------------------------------------------------- Letter :7.1

We conducted our investigation between June 1994 and December 1995. 
Our scope and methodology are discussed in appendix IV. 

As arranged with your office, unless you announce its contents
earlier, we plan no further distribution of this report until 7 days
after the date of this letter.  At that time, we will send copies of
the report to interested congressional committees; the Inspector
General, Department of Defense; the Chief, Procurement Fraud
Division, U.S.  Army; President, Raytheon (which recently acquired
E-Systems); President, E-Systems; and the Chief Executive Officer,
Greenville Division, E-Systems.  We will also make copies available
to others upon request.  If you have questions regarding this report,
please contact me or Assistant Director William L.  Davis III at
(202) 512-6722. 

Sincerely yours,

Donald J.  Wheeler
Acting Director


HOTLINE CASE 66 AT E-SYSTEMS'
GREENVILLE DIVISION
=========================================================== Appendix I


   ALLEGATIONS
--------------------------------------------------------- Appendix I:1

On February 7, 1991, a hotline caller alleged that E-Systems had
built more printed circuit boards and panels than required by
"planning tickets."\6 Further, the caller alleged that a supervisor
had stored excess computer parts in his office and substituted them
on subsequent planning tickets instead of building new parts as
required by the planning tickets. 


--------------------
\6 According to a DCAA Technical Specialist, at E-Systems all
manufactured parts required planning tickets, i.e., written plans and
specifications that accompany the items during their journey from raw
material to finished products. 


   HOTLINE INVESTIGATOR'S FINDINGS
--------------------------------------------------------- Appendix I:2

The hotline investigation substantiated the allegations.  Hotline
investigators found excess printed circuit boards and other parts in
the supervisor's possession after he told them that he had none.  The
supervisor later admitted to (1) substituting excess parts, instead
of building new ones, to fulfill subsequent planning tickets and (2)
falsifying the planning tickets to indicate that he had made new
parts. 

The investigators' subsequent company-wide examination located more
than 130,000 excess parts.  The excess represented parts generally
found in all E-Systems production areas and included such items as
electrical components and sheet-metal parts.  The investigation
report indicated that, counter to company policies and procedures,
the use of excess parts from one contract on another contract was a
historical practice at E-Systems. 

The case was closed January 29, 1992. 


   E-SYSTEMS' REPORTS OF
   INVESTIGATIVE FINDINGS
--------------------------------------------------------- Appendix I:3


      E-SYSTEMS' QUARTERLY REPORT
      TO THE ARMY
------------------------------------------------------- Appendix I:3.1

E-Systems reported the hotline allegations to the Army's Procurement
Fraud Division in a March 29, 1991, quarterly report.  E-Systems did
not report the results of the hotline investigation, dated December
2, 1991, in any quarterly report.  An E-Systems representative told
us the company had "inadvertently omitted" the information. 


      E-SYSTEMS, INC., GREENVILLE
      DIVISION ETHICS COMMITTEE
      REVIEW SUMMARY
------------------------------------------------------- Appendix I:3.2

In a January 1992 report to the Corporate Ethics Program Director,
Greenville's Ethics Program Director concluded that E-Systems' policy
regarding excess parts was "not clear or just not followed" and the
supervisor had made no deliberate attempt to hide or manipulate
contract costs.  The report further concluded that the supervisor had
believed the process he used was beneficial and followed historical
practices. 


      GREENVILLE DIVISION'S
      SUMMARY REPORT
------------------------------------------------------- Appendix I:3.3

One stated purpose of the October 1993 Greenville Division report was
to summarize the circumstances associated with the hotline case. 
However, the report did not address two related critical issues--the
supervisor's initial attempt to mislead investigators about his
possession of excess parts and his falsification of documents
concerning the parts. 


   DEFENSE LOGISTICS AGENCY'S 1994
   COMPLIANCE REVIEW
--------------------------------------------------------- Appendix I:4

In 1994, DLA completed, at the Army's request, a review of E-Systems'
compliance with the Memcor Agreement at the Greenville Division.  DLA
found that, with the exception of the investigator's report, the
Greenville Division reports had minimized the importance of the
investigative findings--mischarging, damage to the government, and
the supervisor's role--by explaining (1) company processes; (2) the
causes of the excess (engineering changes, human error within the
production process, and machinery set-up materials); and (3) the
disposition of the parts. 

DLA concluded that due to the extensive nature of the improper
practices, E-Systems should have (1) requested DCAA and the Defense
Plant Representative Office to participate in E-Systems' review of
the allegations and (2) made full disclosure of the investigation
findings to the government.  In addition, DLA reported that the
supervisor identified should have been disciplined. 


HOTLINE CASE 114S AT E-SYSTEMS'
GREENVILLE DIVISION
========================================================== Appendix II


   ALLEGATIONS
-------------------------------------------------------- Appendix II:1

On January 2, 1991, a hotline caller alleged that E-Systems' quality
control and Material Review Board personnel had rejected--and the
customer, the U.S.  Air Force, had agreed to scrap--two printed
circuit boards.  After the boards had been designated as scrap,
personnel in E-Systems' Engineering Department obtained the boards
and used them in the Air Force's final product.  E-Systems falsified
paper and computer records to remove the Material Review Board
disposition on the boards from "scrapped" to "use as is."


   HOTLINE INVESTIGATOR'S FINDINGS
-------------------------------------------------------- Appendix II:2

The hotline investigation substantiated all the allegations.  The
investigation found that E-Systems' quality control had rejected the
two circuit boards.  The boards were then processed through a
Material Review Board representative, who declared the boards as
"scrap" with the Air Force's approval and generated new planning
tickets to build new boards.  The engineering staff believed the
scrapped boards would be functional if fixed and requested that the
boards be turned over to them for use as test models.  Prior to
returning the boards to the engineering staff, the Material Review
Board representative broke off one corner of each board to show that
they could not be used in a final product. 

About 2 months after the engineering personnel received the scrapped
boards, they canceled the newly generated planning tickets for
replacement boards.  They then had the broken corners of the boards
repaired.  Subsequently, a Material Review Board representative, who
normally performed quality control in sheet-metal areas and not
electronics, was requested to change the original computer records
for the boards from "scrap" to "use as is." He did so.  In addition,
E-Systems charged all costs associated with reusing the boards as an
indirect cost to overhead instead of directly to the contract.  The
company subsequently used the boards in the final product without the
Air Force's knowledge that they had originally been scrapped and had
not been appropriately tested. 

The investigator's report stated,

     "Interviews of the personnel .  .  .  reflects [sic] a total
     departure and callous disregard for Company approved and
     prescribed procedures, overt attempts to hide the fact the
     boards were rejected and scrapped, and efforts from the onset to
     deceive a Quality Control and MRB [Material Review Board]
     representative.  .  .  .  Investigation shows a clear and
     deliberate attempt to by-pass the initial Inspector, Quality
     Assurance, MRB and Customer representatives." (Emphasis added.)

The investigator further noted, "New inspectors, MRB and Customer
representatives were sought out, not given all the details, and
instructed to reverse the process." He continued that E-Systems'
claim of an "urgent need" for the boards did not exist because the
company had had ample time to manufacture the parts after the initial
scrapping. 

The case was closed on January 30, 1992. 


   E-SYSTEMS' REPORTS OF
   INVESTIGATIVE FINDINGS
-------------------------------------------------------- Appendix II:3


      E-SYSTEMS' QUARTERLY REPORTS
      TO THE ARMY
------------------------------------------------------ Appendix II:3.1

E-Systems reported the hotline allegations to the Army in its March
29, 1991, quarterly report.  The caller making the allegations was
concerned that two printed circuit boards that had been rejected and
then sent to Engineering for test work would ultimately be shipped to
the Air Force, which had been informed that the boards were to be
used only for test purposes. 

E-Systems reported the results of the hotline investigation to the
Army in its March 25, 1992, quarterly report.  The report noted that
the investigation revealed that two printed circuit boards had been
scrapped but subsequently changed to "use as is" to meet an urgent
Desert Storm requirement and that this was done with the concurrence
of Engineering, Quality Control, and the Air Force. 


      E-SYSTEMS, INC., GREENVILLE
      DIVISION ETHICS COMMITTEE
      REVIEW SUMMARY
------------------------------------------------------ Appendix II:3.2

In a January 30, 1992, review summary, the Ethics Program Director
did not concur with the hotline investigator's findings, stating ". 
.  .  neither that information nor the interview transcripts
conclusively proves [sic] such conclusions.  .  .  ." The Ethics
Program Director also cited the customer's approval of the repaired
boards' use in the end product.  However, the director recommended
that new procedures, guidance, and changes to the computerized record
system be issued to prevent subsequent changes of previously entered
data. 


      GREENVILLE DIVISION'S
      SUMMARY REPORT WITH
      CONCURRENCE OF E-SYSTEMS'
      OUTSIDE COUNSEL
------------------------------------------------------ Appendix II:3.3

In May 1993, in response to an AFOSI inquiry, E-Systems' Greenville
Division issued--and provided to AFOSI, the Defense Criminal
Investigative Service, and an Assistant U.S.  Attorney--a report that
stated that nothing in the conduct of division personnel "in any way
suggests any element of deception." E-Systems' outside counsel
concurred with the report and justified the employees' actions by
saying their intent was to deliver a functioning system.  Neither the
division report nor the counsel's concurrence specifically addressed
the employees' actions as contained in the hotline investigator's
report. 


   AIR FORCE OFFICE OF SPECIAL
   INVESTIGATIONS SUMMARY
-------------------------------------------------------- Appendix II:4

A February 24, 1994, AFOSI report supported many of the hotline
investigator's findings and included the following information: 

  -- the estimated value of the printed circuit boards, after
     electrical components were added, was about $7,000 each;

  -- E-Systems, in violation of company policy, used a Material
     Review Board member in the Sheet Metal Shop to override the
     circuit boards' rejection by a Quality Control Inspector
     assigned to the circuit board area;

  -- the scrapped boards--repaired and manufactured outside of normal
     procedures--were used and delivered to the Air Force;

  -- the repaired boards were never processed through E-Systems'
     Quality Control section and were not manufactured in accordance
     with military specifications;

  -- some costs associated with the production of the boards were
     charged to overhead rather than to the contract;

  -- E-Systems did not perform any functional tests on the boards
     other than operationally in the end item;

  -- the Air Force was given no monetary consideration when the final
     products (search receivers) were delivered even though costs
     were charged to overhead and then again when the search
     receivers were delivered as an end item;

  -- E-Systems created work orders showing the manufacture of the
     boards, after delivering boards to the Air Force; and

  -- both boards failed in the field, one within months of delivery. 


   DEFENSE LOGISTICS AGENCY'S 1994
   COMPLIANCE REVIEW
-------------------------------------------------------- Appendix II:5

DLA in its 1994 compliance review report to the Army noted that the
hotline investigation had substantiated the allegations of the
improper use of scrapped circuit boards and the changing of records. 
DLA concluded that the hotline investigator's interviews of company
employees had clearly shown deception by Engineering Department
personnel so as not to hold up delivery.  The supervisor who had
repaired the boards admitted to the hotline investigator that the
boards should have been scrapped.  Furthermore, the Material Review
Board representative stated that the boards should have been
destroyed and that he had allowed them to be used only for test
purposes. 

In addition, DLA noted that the interview transcripts contained in
the Ethics Program Director's file showed that a supervisor in the
Engineering Department had made false representations to a government
representative when he said ".  .  .  the only reason those boards
were scrapped was because that corner was notched out." DLA further
concluded that the outside counsel's May 1993 position--that nothing
done by E-Systems or government personnel "suggests any element of
deception"--was in direct conflict with the interview transcripts. 

DLA also reported that E-Systems should have (1) requested DCAA and
the Defense Plant Representative Office to participate in E-Systems'
review of the hotline investigation and, (2) due to the apparent
intentional misconduct involved, fully disclosed the investigation
findings to the government.  In addition, the report noted that
individuals and supervisors identified by the hotline investigation
should have been significantly disciplined. 


HOTLINE CASE 226 AT E-SYSTEMS'
GREENVILLE DIVISION
========================================================= Appendix III


   ALLEGATIONS
------------------------------------------------------- Appendix III:1

On April 19, 1993, a hotline caller made three allegations.  During
the subsequent hotline investigation, the caller made five additional
allegations.  The following summarizes the allegations raised: 

(1-3) The first three allegations in this hotline case involved
personnel matters, not violations of procurement law, and are not
addressed in this report. 

(4) Upon termination of an Air Force contract for aircraft equipment,
E-Systems' Vice President, Finance, caused funds owed to the
government for work completed by the company to be lowered from
$1,348,000 to $1,068,000 without justification. 

(5) The Vice President, Finance, violated E-Systems' ethics policy by
not allowing a voluntary refund to the government for training that
E-Systems had not conducted under a government contract. 

(6) The Vice President, Finance, directed employees to mischarge
their time to overhead instead of to bid-and-proposal costs.\7

(7) A subcontractor submitted inaccurate time charges to E-Systems,
which were subsequently submitted to the government. 

(8) The Vice President, Finance, directed that hazardous duty pay be
added to a government contract after negotiations had been completed
and while the contract was awaiting signature.  The direction was
refused, and another vice president signed the contract without the
addition while the vice president who had given the direction was on
vacation. 


--------------------
\7 Knowingly charging the overhead account for an employee's time
used to prepare bid-and-proposal information on a specific government
contract is a false claim, a violation of 18 U.S.C.  ï¿½ 287. 


   HOTLINE INVESTIGATOR'S FINDINGS
------------------------------------------------------- Appendix III:2

Allegation 4 was not substantiated. 

Allegation 5 was not substantiated.  However, the Division Counsel
sent the Vice President, Finance, a memorandum along with a copy of
E-Systems' voluntary refund policy for the vice president's
consideration.\8

Allegation 6 was substantiated.  The hotline investigator determined
that company procedures required employees to charge their time to
bid-and-proposal costs (and not overhead) when they were doing
technical writing for a contract proposal.  The Division
Controller--under the impression that the Vice President, Finance,
had told employees to charge to overhead--advised several employees
that because they were writing the technical proposal, they should
instead charge their time to bid and proposal.  According to the
investigator's report, these employees stated that the proposal
manager, at the direction of the Vice President, Finance, had told
them to charge overhead because the bid-and-proposal budget had been
overrun. 

According to the Division Controller, permission had to be obtained
from corporate headquarters if the bid-and-proposal budget was to be
exceeded.  The excess still would be charged to overhead, but it
became an unallowable cost and would be taken from the division's
profit.\9 Division Counsel, after being made aware of the matter by
the Division Controller, wrote the Vice President, Finance,
suggesting that he examine the bid-and-proposal issue.  The counsel
told the hotline investigator that the vice president had told the
counsel, in effect, "to mind his own business."

Allegation 7 was substantiated.  A Corporate Internal Audit review of
the subcontractor's inaccurate time charges found that the problem
had been corrected. 

Allegation 8 was substantiated in that the directed insertion of
hazardous duty pay was refused and another vice president signed the
contract.  However, the Vice President, Finance, told the hotline
investigator that the insertion was not improper because the matter
was not a contract; it was a proposal.  He advised that if the
customer objected to the new rates the customer could negotiate them
out. 

The case was closed on December 5, 1993. 


--------------------
\8 E-Systems' ethics policy concerning voluntary refunds states, ". 
.  .  When it is determined that .  .  .  overpricing has occurred,
then it is the Company's policy to refund the amount of the
overpricing even when there is no contractual or legal obligation to
do so."

\9 According to the Chief, Operations Audits, DCAA, E-Systems'
overhead costs are shared by all government customers instead of
being billed to just the one for which the work is done.  He said
that although the bid-and-proposal account is a type of overhead
account, employees may charge up only to a specified limit before the
company begins incurring the costs.  He said when the division
exceeds the limit, charges then become "unallowable." In case 226,
the Greenville Division's bid-and-proposal budget was exceeded. 


   E-SYSTEMS' REPORTS OF
   INVESTIGATIVE FINDINGS
------------------------------------------------------- Appendix III:3


      E-SYSTEMS CORPORATE
      COUNSEL'S SUMMARY REPORT
----------------------------------------------------- Appendix III:3.1

E-Systems' Corporate Counsel determined that some of the various
allegations involved in case 226 involved financial and legal issues
that should be investigated by someone from outside the Greenville
Division.  As a result, it initiated a parallel investigation of the
financial and legal issues to determine if wrongdoing had occurred
and what corrective action should be implemented.  The Corporate
Counsel invited the hotline investigator to attend all interviews
relevant to the allegations he was investigating.  On August 13,
1993, the Corporate Counsel issued a report covering hotline
allegations 4, 5, 6, and 7.  According to the Corporate Counsel
representative who conducted the investigation, these were the only
allegations he examined. 

The Corporate Counsel's report differed from the hotline
investigator's report.  For example, the Corporate Counsel's report
never mentioned that the investigator reported that at least two
employees had directed the mischarging, one being the vice president
whom the Division Controller and the Division Counsel had told that
the charging was incorrect.  Instead, the counsel said, "[S]ome
employees may have charged into overhead accounts rather than [the]
bid and proposal (B&P) account." He said that the employees working
on the program charged to bid and proposal when writing a substantial
portion of the proposal although the majority of the proposal was
written after hours and in small discreet increments. 


      E-SYSTEMS, INC., GREENVILLE
      DIVISION ETHICS COMMITTEE
      REVIEW SUMMARY
----------------------------------------------------- Appendix III:3.2

A December 15, 1993, Ethics Committee Review Summary found that the
hotline investigation ".  .  .  did not reveal wrongful intent as
implied by the caller's statements to the investigator.  The
implication of wrongful intent was apparently motivated by the
caller's high degree of animosity toward the Division Vice
President." Regarding the specific allegations, the report stated the
following: 

Allegation 4--The investigation did not substantiate the allegation
that the vice president had caused a federal repayment to be lowered
without justification.  The report therefore recommended no action. 

Allegation 5--The investigation did not substantiate the allegation
that the vice president had violated ethics policy on voluntary
refunds.  Since the government had accepted the work product, no
action was recommended. 

Allegation 6--The report did not state that the allegation was
substantiated.  However, as corrective actions, (1) the Division
Controller was to issue detailed guidance to employees for labor
charging; (2) the labor charges to identify the financial entries
that should be corrected were audited; (3) DCAA was advised about the
"inadvertent" charging errors and proposed corrections of $33,350;
(4) the Vice President, Finance, position was separated from
responsibilities for the Federal Information Systems proposals and
program; (5) the vice president addressed in the case became the
Federal Information Systems Vice President and a newly selected vice
president assumed the finance position; (6) the former Vice
President, Finance, was required to review division policies and
explain them to his subordinates; and (7) the Greenville Division was
directed to conduct a comprehensive director-level training program
on bid-and-proposal labor charging. 

Allegation 7--The report did not state that the allegation had been
substantiated.  Instead, the report noted that the hotline
investigation had revealed a problem in the calculation of
subcontractor's hours but that the problem had been detected and
corrected before the hotline investigation had begun.  The report had
no recommendations. 

Allegation 8--The report stated that the hotline investigation had
revealed that a proposal, not a contract, existed at the time the
hazardous pay issue arose.  Furthermore, if the hazardous duty rates
had been put into the proposal, the customer would have had an
opportunity to negotiate them out of the contract.  The report had no
recommendations. 


      E-SYSTEMS' QUARTERLY REPORT
      TO THE ARMY
----------------------------------------------------- Appendix III:3.3

E-Systems did not report the five additional allegations in the
quarterly reports covering the period when the allegations were
received.  The report--representing November 1, 1993, to March 31,
1994--that summarized the case after its closure did state that five
additional allegations had been received.  However, E-Systems did not
send this report to the Army because, according to a senior legal
assistant, the Memcor Agreement had expired.  The report identified
one allegation as needing "corrective action." It described that
allegation as improper charging of bid-and-proposal costs and noted
that erroneous instructions had been given to employees, resulting in
about $30,000 of the employees' time being improperly charged. 


   DEFENSE LOGISTICS AGENCY'S 1994
   COMPLIANCE REVIEW SUMMARY
------------------------------------------------------- Appendix III:4

DLA in its 1994 compliance review reached the following conclusions: 

Allegation 4--DLA concurred with both the hotline investigator's and
the Ethics Committee's reports. 

Allegation 5--DLA did not concur with either the hotline
investigator's or the Ethics Committee's reports, saying that the
matter, though not illegal, should have resulted in a voluntary
refund under company policy.  DLA noted that E-Systems' policy had
been violated and that the hotline investigation disclosed that
training, valued at more than $125,000, had not been performed even
though a government representative signed a form indicating that it
had.  DLA reported that the investigation found no indication of
deception on behalf of the company, rather that the government had
mishandled the situation. 

Allegation 6--DLA concurred with the hotline investigator's report
that the allegation was substantiated.  However, it did not concur
with the company's corrective actions regarding the labor charging,
including its lack of disciplinary action against the individuals and
supervisors identified in the mischarging.  According to DLA's
report, the hotline investigator specifically questioned the Vice
President, Finance, on his directions regarding bid-and-proposal
costs.  DLA reported that, at a minimum, it was the vice president's
responsibility to ensure proper charging of costs.  DLA concluded
that further inquiry into and elaboration of employee statements may,
in fact, demonstrate intentional direction to employees to mischarge. 

Allegation 7--DLA did not concur with the Ethics Committee's report
that no action be taken.  According to DLA's report, the extent of
apparent subcontractor mischarging--1,000 hours--merited further
examination and formal reporting to the appropriate government
authority.  Further, although the company hotline file included a
statement to the effect that the government's Contracting Officer had
been notified, DLA noted that nothing had been presented in writing. 

Allegation 8--DLA concurred with the hotline investigation and the
Ethics Committee's report saying that the facts in the allegation
were correct and that the investigation did not disclose any apparent
violation of law, regulation, or company policy. 

Overall, DLA disagreed with E-Systems' actions regarding hotline case
226.  The report noted that individuals and supervisors identified in
the mischarging allegations should have been significantly
disciplined.  The report also stated that E-Systems should have (1)
requested DCAA and the Defense Plant Representative Office to
participate in E-Systems' review of the hotline investigation and (2)
made disclosure to the government due to the apparent intentional
misconduct involved.  The report also noted that the Corporate
Counsel's summary appeared to conflict with the information obtained
during the course of the hotline investigation. 


   AIR FORCE OFFICE OF SPECIAL
   INVESTIGATIONS
------------------------------------------------------- Appendix III:5

In an October 18, 1995, report, AFOSI confirmed the hotline
investigator's findings related to the employee mischarges
(allegation 6).  The report noted that DCAA estimated that E-Systems'
actions cost the government about $228,000 because of the manner in
which the company had charged labor rates on contracts negotiated
prior to and after the allegations were raised.  The report
acknowledged the original $33,000 that E-Systems had credited to its
overhead accounts, saying that DCAA believed the amount was
inadequate. 

After the Department of Justice declined to pursue either criminal or
civil action regarding the mischarging, AFOSI and DLA referred the
matter to the Defense Plant Representative Office at E-Systems'
Greenville Division for "appropriate contractual action." As of April
18, 1996, according to a DLA official, resolution of the matter was
pending. 


METHODOLOGY
========================================================== Appendix IV

The then Chairman, Subcommittee on Oversight and Investigations,
House Committee on Energy and Commerce, asked us to investigate
allegations presented by the former chief investigator for E-Systems'
Greenville Division.\10 We conducted our investigation from June 1994
to December 1995. 

To obtain the information in this report, we examined Federal
Acquisition Regulations, Defense Federal Acquisition Regulations and
related guidance, Federal Criminal Code and Rules, the DCAA Contract
Audit Manual, the Department of Defense OIG Indicators of Fraud in
Defense Procurement, the President's Blue Ribbon Commission on
Defense Management Report, the Defense Industry Initiatives, and
Department of Defense documents.  We also examined the Memcor
Agreement, which recognized the establishment of E-Systems' Standards
of Business Conduct and Ethics and the company's compliance with the
Defense Industry Initiative on Business Ethics and Conduct.  We
examined written communications and reports of interviews between the
company, DLA, DCAA, and the Army on the Memcor Agreement's
requirements, the company's performance under that agreement, and the
1994 administrative agreement.  We also examined AFOSI reports
regarding all three hotline cases. 

We interviewed E-Systems corporate and Greenville Division officials
and staff, including the former chief investigator and Greenville's
Ethics Program Director for 1989-92.  We also interviewed responsible
AFOSI, Army, DLA, DCAA, Defense Plant Representative Office, and
Defense OIG officials and obtained documents pertaining to the
oversight of E-Systems' activities.  However, two knowledgeable
employees of the Greenville Division Facilities Protection and
Investigations Division--a second former Ethics Program Director and
a hotline investigator--would not meet with us.  In addition, three
corporate employees--one of whom had been an Ethics Program director
for the Greenville Division--declined to answer certain questions
pertinent to our investigation. 

We reviewed E-Systems' synopses contained in its hotline log and
quarterly reports of the 260 cases opened between June 1987 and
November 1994.  E-Systems' former chief investigator at the
Greenville Division, who had alleged E-Systems' mismanagement of
hotline investigations, provided us copies of his investigative
reports and records and background relative to investigations that he
and his investigative staff had conducted on three hotline
complaints.  We reviewed hotline case file documents obtained from
E-Systems' hotline case files and the Army Procurement Fraud
Division.  We focused our review on the three cases that had been
brought to the Subcommittee's attention and DLA's April 1994 report
related to them. 


--------------------
\10 According to the former chief investigator, he had previously
served 20 years as an investigator and supervisor for the Army's
Criminal Investigations Division Command and 7 years as an
investigator and supervisor for E-Systems' Facilities Protection and
Investigations Division at E-Systems' Greenville Division. 


MAJOR CONTRIBUTORS TO THIS REPORT
=========================================================== Appendix V

OFFICE OF SPECIAL INVESTIGATIONS,
WASHINGTON, D.C. 

William L.  Davis, III, Assistant Director
M.  Jane Hunt, Senior Communications Analyst
Barbara Alsip, Communications Analyst

DALLAS REGIONAL OFFICE

Christina M.  Nicoloff, Project Manager

OFFICE OF THE GENERAL COUNSEL,
WASHINGTON, D.C. 

Barbara C.  Coles, Senior Attorney


*** End of document. ***