-------
-------
w
UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
WASHINGTON, D.C. 20400
SEP30B9I
OFFICE OF
THE INSPECTOR GENERAL
MEMORANDUM
SUBJECT:
FROM:
TO:
Special Review of Allegations of Improprieties and
Management of the Interim Computer Workstation Contract
Special Review Repot No. E6EMPO-15-0039-1400060
r Audit (A-109)
Kenneth A. Konz /»*
Assistant Inspector General
c
Christian R. Holmes
Acting Assistant Administrator for
Administration and Resources Management (PM-208)
SCOPE AND OBJECTIVES
This report presents the results of a special review of
allegations concerning violations of Government procurement laws
and regulations when EPA entered on July 3, 1990, into a $67.5
million procurement with a minority-owned firm, American coastal
Industries (ACI), through the Small Business Administration (SBA)
8(a) Program. The primary objective of our review was to
determine whether the following allegations, made in a letter to
the Inspector General, were valid.
~ How could ACI, a manufacturer of ammunition containers for
Department of Defense, qualify as a manufacturer or dealer
of computers in accordance with the Walsh-Healey Public
Contracts Act?
Why was this SBA set aside contract not providing products
of small businesses as required by an SBA rule, but was
instead providing EPA with products of IBM, SUN, and GRID
(replaced by NCR since the allegation)?
— Why was this sole source award not bound by the Business
Opportunity Development Reform Act of 1988, which prohibits
sole source procurements to 8(a) firms in excess of $5
million for manufacturing?
-------
In addition to our primary objective, other issues which surfaced
during our review were whether:
ACI .is eligible for 8(a) status;
— EPA's contract support within the Procurement and Contracts
Management Division (PCMD) was appropriate under the
circumstances; and
-- EPA has acquired equipment at lowest cost, with all other
factors considered.
The review period included actions related to the ACI contract
from April 1989 through July 1991. To accomplish our objectives,
we held discussions with appropriate EPA, SBA, General Services
Administration (GSA), and ACI officials. We examined documents
pertaining to the ACI contract award, and reviewed applicable
Federal and Agency policies and procedures on the procurement of
computer systems. Additionally, we compared negotiated contract
amounts in the Pre/Post Negotiation Plan (PPNP) with actual
expenses incurred. This was accomplished through examination of
ACI's Communication Systems Group's actual expense figures
contained in the income statements for the periods ending
December 31, 1990, and March 31, 1991. Applicable home office
expenses were also included in the actual expense calculations;
We made cost/profit projections relative to the ACI contract
based on the .assumption of full contract performance (i.e., $67.5
million). Our decision to use full contract performance and
further details of our methodology are explained in Exhibit A.
In matters regarding 8(a) contracting, we consulted SBA's program
experts and EPA's Office of General Counsel and found past
precedents in resolving similar contractual matters.
Because this review disclosed material weaknesses related to
EPA's 8(a) pre-award process and contract management, we also
reviewed the Federal, Managers' Financial Integrity Act (FMFIA)
evaluation process within PCMD to determine why these weaknesses
were not identified internally.
Due to its limited scope, this review does not represent an audit
in accordance with the Government Auditing Standards (1988
revision) issued by the comptroller General of the United States.
Our review was performed in accordance with the procedures set
forth in the Office of Inspector General Manual, Chapter 150,
"Special Reports".
SUMMARY OF FINDINGS
We found that the three allegations were not valid. However,
while no violation of the law existed concerning the allegations,
we believe the ACI procurement was not handled in the most
appropriate manner. EPA did not make a prudent decision in
-------
awarding a $67.5 million interim contract to an 8 (a) firm. In
fact, EPA missed an opportunity to spend its contract dollars in
a way that could have benefitted several 8 (a) businesses rather
than only one business. For example, we believe that EPA would
have better served its own interests, those of the 8(a)
community, and the objectives of the 8(a) program by awarding
smaller contracts and allowing other 8(a) firms capable of
fulfilling the contract an opportunity to participate in the
acquisition. In addition, EPA has not cost effectively managed
the award of the follow-on competitive workstation acquisition
and administered the ACI contract, resulting in unnecessary costs
of about $8.4 million over the life of the Contract. Further,
negotiated amounts of major operating expense items paid by EPA
exceeded actual costs incurred by ACI by about $2.3 million (see
Exhibit 8).
In our opinion, the 8(a) pre-award process and contract
management deficiencies identified in this report are material
weaknesses which meet EPA's materiality criteria for reporting to
the President and Congress in conjunction with Office of
Management and Budget (OMB) Circular A-123 and the FMFIA. The
ACI contract represented a material part of EPA's 8(a) program in
fiscal 1989 through 1991. Until corrected, these conditions
significantly weaken safeguards against the waste of EPA's funds.
In addition, these internal control weaknesses could result in
adverse publicity or embarrassment to the Agency, thereby
diminishing EPA's credibility or reputation.
The Acting Assistant Administrator for Administration and
Resources Management provided us formal written comments on our
draft report in a memorandum dated September 25, 1991. He agreed
with three of the eight recommendations in the report. To
provide a balanced understanding of the issues, we have
summarized management's position at appropriate locations in the
report and provided their verbatim comments in Appendix 1.
ACTION REQUIRED
In accordance with EPA Directive 2750, the action official is
required to provide this office with a written response to the
report within 90 days of the report date. For corrective actions
planned but not completed, reference to specific milestone dates
will assist this office in closing this report. In addition, we
request that you reconsider Recommendations 4 and 5 in Section 3
and Recommendations 1, 2, and 3 in Section 4.
BACKGROUND
At the onset of this procurement in April 1989, EPA planned to
issue two competitive awards for 18,000 workstations, 2,000 local
area network (LAN) servers, associated peripherals, software, and
services at a total estimated cost -of $285 million; Award of the
-------
competitive contracts was originally expected in June 1990, and
the contracts were to last until 1997. Because of delays in the
procurement process and an increased demand for workstations, EPA
altered their procurement strategy by (1) combining products and
services in the two previous planned competitive awards into one
requirement and (2) splitting the total requirement equally
between an 8(a) firm and a follow-on competitively selected firm.
In pursuing the above strategy, EPA applied for a GSA Delegation
of Procurement Authority (DPA) totaling $142.5 million and
approval from SBA to buy ADP equipment from an 8 (a) firm over a
2-year period. In November 1989, GSA reduced the total value of
the request for 3(a) procurement from $142.5 million for 9,000
workstations and 1,000 LAM servers to $67.5 million for 5,640
workstations and no LAN servers, 'in the same month, GSA granted
a DPA for the reduced amount and quantity. In September 1989,
SBA assigned a National Buy Number which provided authority to
negotiate with the same 8(a) firm. The remaining requirement of
ADP equipment totaling 12,360 workstations and 2,000 LAN servers
was reserved for the competitively awarded firm.
The ACI computer workstation contract was awarded July 3, 1990.
It is an interim firm-fixed price, indefinite delivery/indefinite
quantity (IDIQ) contract awarded for a 17-month period, totaling
$67,547,300. However, the indefinite quantity provision stated
in the contract only committed EPA to order the minimum quantity
threshold of $250,000 per fiscal year. The ACI contract is
currently in its first contract option period ending September
1991, and EPA officials plan to implement the second option which
will expire in December 1991.
In November 1990, EPA officials requested an amendment to the
original DPA to increase it by approximately $25 million for an
additional 2,000 workstations and 120 LAN servers. In March
1991, GSA" approved EPA's request to modify the DPA for the
acquisition of the additional workstations and LAN servers with
no increase in funding (i.e., by reducing procurement of other
items in the contract). As of July 1991, EPA had incorporated
this amendment into the ACI contract scope.
EPA is in the process of awarding the competitive workstation
contract estimated at $206 million. As of September 1991, EPA is
awaiting submission of vendor best and final offers. Award of
the contract is planned for December 1991.
-------
RESULTS OF REVIEW
1. ALLEGATIONS OF VIOLATIONS OF 3(a) PROCUREMENT REGULATIONS ARE
NOT VALID
In a letter to the Inspector General, a marketing firm
representing small and disadvantage^ businesses made three
allegations regarding whether EPA properly applied 8(a)
procurement regulations in awarding the interim workstation
.contract to ACI. We concluded that all three allegations were
not valid. A discussion of each allegation follows.
How could ACI qualify as a manufacturer or dealer of
computers under the Walsh-Healey Public Contracts Act?
SBA determined that ACI's Business Plan showed a logical
progression into the computer manufacturing industrial
classification. "Applying the "newly entering into a
manufacturing activity" criteria as defined in Federal
Acquisition Regulation (FAR) 22.606-1, SBA approved awarding the
contract to ACI as a manufacturer.
However, this approval was not given easily. SBA officials
disagreed among themselves before the approval was granted.
Officials within SBA's Washington District Office recommended
that the contract not be awarded. These officials stated that
(1) the activities to be contracted for were not manufacturing;
(2) the offerer had substantial financial risk based on interim
financial statements reviewed; and (3) ACI had not demonstrated
the ability to perform computer manufacturing. After extensive
discussion and research of SBA's Office of Hearings and Appeals
case precedents, the Region III Administrator decided that a fair
interpretation of the rules did allow the signing of the
contract. A note appended to the decision describes the SBA
Region III Administrator's concern over the current inability to
fairly and consistently evaluate what constitutes computer
manufacturing.
Whv was this SBA set aside contract not providing
products of small businesses as required by an SBA
rule?
If the 8(a) contractor were a non-manufacturer, then the Code of
Federal Regulations (CFR) requires that the contractor.must
supply the product of a small manufacturer (13 CFR 121.906).
However, 13 CFR 124.314 provides that, in the case of an 8(a)
concern that seeks to perform the requirement as a manufacturer,
it must perform work for at least 50 percent of the contract cost
excluding the cost of material. This latter rule applied to_ACI.
Therefore, SBA determined that ACI would be performing as a
manufacturer.
-------
Whywas this sole source award not limited toS5 millionby
the Business Opportunity Development Reform Act of 1988?
The ACI procurement was not bound by the competition requirement
in the Business Opportunity Development Reform Act of 1983 (the
Reform Act), P.L. 100*656, because it was accepted into the 8(a)
program prior to the effective date of the competitive threshold
provision under the Act. Section 303(b) of the Reform Act
establishes monetary competitive thresholds for 8(a)
procurements. Prior to the Reform Act, there was no requirement
for competing an 8(a) procurement. As of October 1, 1989,
manufacturing contracts with an anticipated award price of over
$5 million are to be awarded on the basis of competition among
eligible 3(a) participants.
Pre-award documents show that ACI self-marketed itself to EPA's
National Data Processing Division in September 1989, seeking an
8(a) contract to provide computer workstations and associated
services and equipment to EPA. The contracting officer initiated
this 8(a) procurement on September 26, 1989, under priority
conditions to acquire SBA's acceptance of the EPA offer prior to
the effective date of the competition requirement. SBA assigned
a National Buy Number on September 27, 1989, and accepted the
offering on October 10, 1939, to provide EPA with small computers
and local area networks. The estimated value of the offering was
$142.5 million. The $142.5 million was later materially reduced
to $67.5 million by GSA. SBA determined that procurements
accepted in this manner could be processed under the rules in
effect prior to the Reform Act, if the award was made within one
year.
The legislative history of the Reform Act shows that Congress
intended that contracts in the final stages of negotiation as of
the effective date of this provision were to be excluded from the
competition requirement. The Conference Committee in its report
(H.R. 100-1070), defines contracts in the final stages of
negotiation as those in which "SBA has accepted the requirement
for the program and a proposal containing price has been
submitted to the buying agency."
SBA's regulations (13 CFR I24.311(b)} implementing the thresholds
for competition only mandate that SBA accept the requirement into
the 8(a) program before October 1, 1989. A September 8, 1989,
memorandum issued by SBA's Assistant Administrator for Minority
Small Business Capital Ownership and Development provided
guidance. The memorandum stated that national buy requirements
above the threshold, offered and assigned a National Buy Number
by September 30, 1989, would be awarded through the 8(a) sole
source process. SBA's decision not to require the submission of
a price proposal was based on comments and concerns voiced by
dissenting 8(a) firms during the promulgation of the regulation.
SBA agreed with the comments that it was not fair to require the
-------
submission of a price proposal prior to October 1, 1989, if 8(a)
businesses expended valuable time and monetary resources in
negotiating contracts.
Although we concluded that the three allegations were not valid
and found no violations of the law in these matters, we
identified other significant areas of concern with this
procurement process. These concerns are discussed in the
following sections.
\
-------
2- DECISIONS MADE IN THE PRE-AWARD PROCESS WERE INAPPROPRIATE
We believe that the interim contract was not handled in the most
appropriate manner. EPA did not make a prudent decision in
selecting ACI and the interim contract award goes beyond the
intent of the 8 (a) program.
EPA Did Not Make A Prudent Decision In Selecting ACI
PCMD did not adequately determine whether ACI was qualified to
perform the contract prior to recommending that SBA approve ACI
as the 8(a) contractor. In May 1990, SBA recommended against
approving the contract citing: (a) ACI's deficiency as a going
concern; (b) no demonstrated ability to perform computer
manufacturing; and (c) the procurement could not be considered
computer manufacturing. Nevertheless, EPA officials continued to
aggressively pursue SBA approval of the ACI contract. In
addition, concerns about the adequacy of ACI's accounting system
were ignored rather than seeking a more qualified firm.
SBA accepted the EPA offering to the 3(a) program in September
1989. This acceptance was not a contract approval since SBA
conducts a comprehensive evaluation of the procurement and the
8(a) contractor prior to approving each award. In May 1990, when
EPA submitted the contract for SBA approval, SBA Business
Opportunity Specialists reviewing the contract file strongly
recommended against approval. Nevertheless, as a result of
pressure from ACI and EPA, SBA's Region III Administrator
reversed SBA's position in July 1990. While the Region III
Administrator overruled the specialists, we believe the position
taken by the specialists was accurate because the evidence did
not support that ACI was able to perform this contract unless ACI
maintained a stronger cash flow position. As a result, we
believe the Agency has had to pay substantially higher prices to
eliminate that risk.
SBA gave the 8(a) firm a poor rating in May 1990, compared to the
industry averages in the areas of liquidity, leverage, operating
efficiency, and profitability. SBA reviewed cash flow
projections and the firm's line of credit and determined that ACI
did not have the financial capacity to perform the contract.
Data received from SBA also showed that ACI was not financially
solvent. For example, the records showed that for the year
ending December 31, 1989, the firm had a negative working capital
of $1,617,833 and a minus net worth of $3,664,627. Total sales
for the period were $24,491,796 with a poor current assets to
liabilities ratio during the fourth quarter of .72.
ACI's capacity to perform computer manufacturing was also not
demonstrated. It was not previously in that business and had no
computer manufacturing facilities, but ACI presented itself as a
"newly entering" computer manufacturer when it solicited the EPA
8
-------
u
contract. We consider it reasonable to assist a.firm engaged in
moving into a new business field with a contract having a
smaller, more defined scope of work. However, for larger and
more complex contracts such as the ACI contract, the prudent
decision would be to select multiple 3(a) firms which had already
demonstrated competency in computer manufacturing.
EPA officials were aware that ACI had never constructed a
rigorous accounting system that was acceptable to the Government
prior to award, yet did not initiate action to ensure the system
complied with Government requirements and cost accounting
standards. EPA's cost analyst had difficulty obtaining
information from ACI and finding consistently applied policies
~| regarding ACI's incentive compensation plan and several other
areas. The Pre/Post Negotiation Plan stated that ACI officials
acknowledged that some areas of their accounting system needed
improvement. EPA's cost analyst suggested to ACI that EPA may
want to audit the firm upon receipt of the first ACI voucher.
Moreover, the contracting officer requested information from the
Defense Contract Audit Agency (DCAA) on ACI's accounting system.
A December 6, 1989 PCMD memorandum showed that DCAA stated that
ACI's General & Administrative (G & A) rate increased from 7.5
percent to 27 percent in one year. However, ACI failed to
document and explain this increase when requested by DCAA.
Furthermore, during their attempt to audit the Arlington office
of ACI, DCAA faced delay tactics and after two months of such
tactics, DCAA was forced to issue a report saying they could not
verify the G & A being proposed by ACI. This experience prompted
a strong recommendation from DCAA that no Government contracts
should be awarded to ACI until a site audit was performed.
However, PCMD never requested or initiated an audit based on
these internal and DCAA recommendations.
ACI never constructed a rigorous accounting system that would be
more acceptable to the Government since previous contracts were
firm-fixed price. EPA's ACI contract was also a firm-fixed price
contract. However, in order to conduct a post-award audit to
determine cases of defective pricing, an approved accounting
system would be very useful. For example, we were unable to
determine causes of large variances between negotiated and actual
operating expenses due to discrepancies in ACI's accounting
system. (See pages 18-21.) It is not in the Government's best
interest for EPA to ignore these deficiencies for a $67.5 million
contract when other 8(a) firms have approved accounting systems.
The Interim Contract Award To ACI Goes Beyond TheIntent Of
The 8(a)Program
Section 8(a) of the Small Business Act (15 U.S.C. 637(a)} is a
primary tool for improving Federal procurement opportunities for
small business concerns owned and controlled by socially and
-------
economically disadvantaged individuals, and for bringing such
concerns into the nation's economic mainstream. In the Business
Opportunity Development Reform Act of 1988, Congress stated that:
the 8(a) program had generally failed to meet its objectives;
there was a widespread perception of undue political influence in
the operation and administration of the program; and program
benefits had not been equitably distributed. While we support
the purposes of the 8(a) program, we share these concerns
expressed by Congress. In fact, we believe that this contract .
award is an example of why the 8(a) program objectives are
failing for the following reasons.
— ACI's minority owner has ownership or management interests
in several industries raising questions regarding the
legitimacy of his "small and disadvantaged1* status and
degree of his involvement in the day-to-day operations of
the firm. One affiliated enterprise, upon which ACI's
minority owner sits as Chairman of the Board of Directors,
has recently won a multi-year $1 billion healthcare award
with the State of Pennsylvania. Exhibit C illustrates the
network we identified of the minority owner and his wife's
business ventures. Furthermore, ACI and its owner are the
subject of other ongoing investigations of related party
transactions by Congress, Department of Health and Human
Services, and General Accounting Office (GAO). PCMD
officials related that they were aware of some but not all
of the owner's affiliations.
— EPA awarded a single firm a $67.5 million contract. As
stated earlier, the purpose of creating the 8(a) program was
to help bring small disadvantaged business concerns into the
economic mainstream. The general policy of the Government
is to place a fair proportion of its acquisitions with small
business concerns and small disadvantaged business concerns
(48 CFR 19.201(a)). Through the ACI contract, EPA placed a
fair proportion of acquisitions with a small disadvantaged
business, but missed the point of the 8(a) program. EPA had
an opportunity to spend its contracting dollars in a manner
which would have benefitted several 8(a) businesses, but
instead it chose to award one of the largest 8(a)
procurements in several years to a single firm. This choice
benefitted only one business, to the derogation of other
8(a) participants who were excluded from participation. For
example, SBA provided a list of 25 8(a) firms having the
capabilities, to perform computer manufacturing. Any of
these firms could have been awarded a bona fide interim 8(a)
contract to bridge the gap between the EPA workstation «*
contracts existing prior to ACI and the competitive award.
In addition, multiple 8(a) awards were warranted to provide
short term purchasing capability, and shorter term contracts
-------
Senate Report No. 100-394 dated June 22, 1988 on the
Business Opportunity Development Reform Act of 1988, said
the competitive threshold requirements were included for two
reasons: (a) to foster development of competitive skills
essential to the 8(a) participants after graduation from the
program; and (b) to act as an effective safeguard against
abuses that can flourish in a sole-source contract award
environment that is presently free of any effective,
institutional checks.
While it is true EPA was not bound by statute to compete the
3(a) contract, in light of the well publicized problems and
-scandals of the 8(a) program and the reasons Congress chose
to overhaul the program in 1938, EPA would have better
served its own interests, those of the 8(a) community, and
the objectives of the 8(a) program by allowing other 8(a)
firms capable of fulfilling the contract an opportunity to
participate in the acquisition.
— IDIQ contracts currently can take advantage of a loophole in
the regulations which allows establishing an indefinite
maximum amount above the $5 million ceiling. This was
brought to our attention by a PCMD official. The ACI
contract is categorized as an IDIQ having a guaranteed
minimum value of $250,000, which obligates EPA to spend at
least $250,000 each fiscal year. A special provision of SBA
regulations (13 CFR 124.311) defines the guaranteed minimum
value of IDIQ contracts as contract value for purposes of
determining need for 8(a) competition.
Although not a factor for this contract, if abused in the
future, the IDIQ provision could have the effect of negating
the competition rule. To clarify the intent of this
loophole we contacted SBA's Office of General Law. The
attorney involved in writing that regulation stated to us
that the intent of this provision was to relate the
exception to contracts in certain circumstances having a
maximum value just over the threshold, but was certainly
never intended to apply to contracts of the magnitude of
$67.5 million. The SBA official found the provision to be
confusing and inconsistent with the intent of the program,
and advised us of SBA initiatives to revise the regulation
removing the provision. Senior EPA program officials
expressed agreement with this issue.
While it is too late to initiate corrective actions regarding the
issues discussed in this section for the current contract,
additional management attention and oversight is needed over the
selection and management of future 8(a) procurements.
Strengthening the FMFIA process relative to 8(a) procurements
-------
could contribute to improving accountability and control over
8(a) procurements. (See discussion of the FMFIA process on pages
22-24.)
-------
3. EPA INCURS SIGNIFICANT EXCESS COSTS IN THE AGENCYWTDE
PROCUREMENT OF MICROCOMPUTER WORKSTATIONS
SPA has (a) unnecessarily delayed the award of the competitive
workstation procurement by 12 months and (b) not cost effectively
administered the ACI interim workstation contract. As a result,
EPA is paying an estimated $8.4 million higher than market prices
for microcomputer workstations over the life of the contract.
Further, we believe if the competitive award is not made by
December 1991, when ACI's last contract option expires, the lack
of a source of microcomputers will adversely impact EPA's
operations. The primary causes for the delays and ineffective
contract administration were limited procurement resources and
changing management priorities.
In addition, we found that negotiated line item expenses are
significantly greater than actual operating expenses incurred
under the ACI contract. As a result, EPA is paying an estimated
$2.4 million for operating expenses above what ACI actually
incurred. Possible causes include inaccurate accounting,
ineffective negotiations, and defective pricing. A more detailed
review of supporting records is required to determine actual
causes, but this was beyond the scope of our review. Conse-
quently, other OIG auditors are currently examining the causes in
more detail in another OIG review.
Delay In Awarding The Competitive Contract Will Cost EPA
Millions Of Dollars
As part of the acquisition planning requirements prescribed by
Part 7 of the FAR, EPA's PCMD uses individual procurement plans
to track acquisitions from the pre-solicitation stage to final
.award. Procurement managers rely on milestones to fulfill their
mission, as a means to track the progress of each procurement,
and estimate workload and staffing needs. Contracting officers
review the award status and update the procurement plan on a
monthly basis.
During the competitive workstation solicitation phase, GSA
expressed concern that the competitive portion of the workstation
contract would not be kept on the schedule stated in the
procurement plan. Despite this concern, GSA granted a DPA under
the condition that EPA concentrate its resources on the
competitive award. Further, in March 1991, GSA approved EPA's
request to modify the DPA for the acquisition of the additional
workstations and LAN servers with no increase in funding (i.e.,
by reducing procurement of other items in the contract). As of
July 1991, EPA had incorporated this modification into the ACI
contract scope.
EPA experienced significant delays in awarding the competitive
workstation contract. EPA's award of the competitive workstation
-------
contract was initially estimated to require 14 months. Cur-
rently, the award is estimated to take 33 months — 19 months
beyond the original scheduled date of June 1990. The 19-month
delay, from June 1990 to December 1991 (current estimated award
date), is described below:
— 5 months resulted from the unexpected high volume of
responses received from EPA's solicitation process on the
competitive award;
— 2 months resulted because EPA received a protest in May
1991, which was resolved in June 1991; and
— 12 months resulted, primarily, because: (a) staff was
diverted at critical times in the competitive workstation
procurement and put on awarding the interim contract;
(b) management priorities changed (i.e., the award, of a
supercomputer acquisition contract took precedence over the
competitive workstation award due to Congressional
interest); and (c) one official indicated there was no
incentive to issue the competitive contract since the
interim contract was in place.
While the 2- and 5-month delays resulted from unforeseen
circumstances, the rationale for the remaining 12 months was
inappropriate to delay an award estimated at $206 million. In
our opinion, GSA's advice to concentrate on the competitive
workstation contract, and the award's importance to all EPA's
operations, made it critical to award this contract in a timely
manner. Moreover, in examining the 12-month delay, it is evident
that the award decision was, for the most part, within the
control of management. If more resources had been put on the
computer workstation award, this lengthy delay could have been
significantly reduced, or even eliminated.
As a result of not awarding the competitive workstation contract,
EPA continues to pay significantly higher than market prices for
microcomputers. The delays in issuing the competitive award may
cost EPA up to an estimated $3.4 million for ADP equipment above
fair market prices over the life of the interim contract (see
Exhibit A). Procurement officials agreed that ADP equipment
under the competitive workstation procurement will cost less
because of larger quantity requirements. Moreover, further
delays past December 1991 will adversely impact EPA operations.
EPA collects and processes enormous amounts of data in order to
protect and monitor our nation's environment. Microcomputer
workstations are a critical tool in automating the data process-
ing tasks and performing supporting activities. Consequently, an
award as soon as possible is critical to EPA's operations, since
the current interim contract expires in December 1991, and no
other Agencywide source of microcomputers exists.
11
-------
As a result of our May 30, 1991, meeting with the Assistant
Administrator for Administration and Resources Management and
subsequent discussion with procurement officials, EPA management
agreed to expedite the award to September 1991. However, because
of a protest, the planned award date was subsequently revised
back to December 1991. We believe that EFA should issue the
competitive contract no later than December 1991.
Ni
Better Administration Of The ACT Contract Could
Avoid Some Costs
The responsibility for proper and effective contract adminis-
tration rests with the authorized contracting officer. Section
1.602 of the FAR prescribes that "contracting officers are
responsible for ensuring performance of all necessary actions for
effective contracting, ensuring compliance with the terms of the
contract, and safeguarding the interests of the United States in
its contractual relationships." This responsibility includes the
authority to enter into, administer, or terminate contracts and
make determinations and findings with respect to the contracts.
In multi-year, firm-fixed price contracts such as ACI, adminis-
tration of ADP equipment prices is of prime importance,
especially prior to exercising contract options. Section 17.207
of the FAR prescribes that "the contracting officer may exercise
options only after determining that ... [it] is the most
advantageous method of fulfilling the Government's need, price
and other factors considered." To comply with this requirement
the contracting officer should determine whether the ACI contract
prices are better than prices available in the market.
EPA's contracting officer did not use all means available to the •
Government to initiate action in order to save money. As of June
1991, EPA had modified the contract 12 times, involving 89 line
item adjustments (i.e., 40 add-ons or quantity increases and 49
deletions or quantity decreases). All of the modifications
involving changes to contract line items — except for changes in
requirements ~ have been recommended by ACI. These
modifications to the contract resulted from adjustments in
requirements, engineering changes, substitutions, or burn-in
failure.
However, there were other opportunities to affect prices which
were not considered. For example, EPA's initial requirements at
the onset of the award contained estimated quantity level and a -
corresponding price based on that quantity. As of June 1991, EPA
had modified 15 line items adding to the quantities, but had not
taken action to obtain a cheaper price for the items based on the
quantity increase. Thus, EPA is not benefiting from volume
buying, when quantities increase. In addition, the contract
includes items where market prices have decreased significantly
11
-------
since award, even though the quantity requirements have remained
constant since contract inception.
As a result of not exercising options available, EPA is paying
significantly higher than market prices for at least some
individual contract line items. The table on the next page
provides examples of ADP equipment on the ACI contract where the
contract line item prices are significantly greater than the
current quoted prices. Modifications decreasing the price of
these four line items could result in a cost avoidance of about
$2.7 million if the total quantity of the items were purchased.
Although we did not estimate the aggregate decrease in the price
on all line items, a comparison between negotiated amounts and
actual ACI ADP equipment costs shows that actual prices are
cheaper by 12.56 percent (see Exhibit A). Thus, it is in EPA's
best interest to incorporate quantity discounts and price
decreases in administering the ACI contract.
PCMD officials indicated that prices for some of the new products
(i.e., replacement or upgraded items) have resulted in a price
competitive with the current market price. We agree that several
of the modifications in July 1991 for replacement items (which
occurred subsequent to the completion of our analysis of the 12
modifications) would mitigate the price differential. For
example, nine modifications issued in July 1991 resulted in
current market prices for 18 new line items. However, this
modification process does not include all original contract line
items where prices are significantly greater than fair market
prices.
The contracting officer told us that adequate staff was not
available to keep up' with the current market prices and to make
adjustments for the decreases in market prices. The contracting
officer also indicated the ACI contract is only one of 30
contracts that she administers. Further, procurement officials
indicated that a price change to ACI could be suggested, but
because of the fixed nature of the contract, the contractor does
not have to renegotiate. However, according to Section 17.207 of
the FAR, the contracting officer must determine that the prices
are advantageous to the Government prior to exercising ACI
contract option 2 (i.e., extending the contract period to
December 1991). Therefore, we believe EPA should try to strongly
suggest lower prices where contract prices are significantly
higher than the market as soon as 'possible. Further, should ACI
disagree, EPA should consider restricting future purchases of
contract line items which are priced significantly higher than
the market. This has been done previously for two contract line
items.
-------
EXAMPLES OF ACT CONTRACT PRICES SIGNIFICANTLY •
GREATER THAN PRICE QUOTES '
Line Contract Quoted Variance * Estimated Excess
Item Price ' Price Quantity Cost to EPA
Basic MS-
DOS/052
System $1,586 $850 $736*2,306 $1,697,216
Token Ring
Adapter $544 $351 $193*4,501 $868,693
Color
Monitor $862 $649 $213*145 $30,885
•»
Postscript
Laser
Printer $2,427 $1,554 $873*85 $74,205
Total $2,670,999
1 The quoted price data was obtained by soliciting quotes from
a major retail vendor involved in Government contracting.
Individual ACI contract line item specifications were provided to
the vendor in obtaining a basis for the ADP equipment comparison.
The quantity represents the current quantity remaining on the
contract as of June 11, 1991, adjusted for actual quantities
resulting from the March DPA amendment. A 24.3 percent surcharge
was subtracted from the ACI contract price in determining the base
price of the equipment. This table contains four of the eight
contract line items from a July 1991 vendor quote. The quoted
price for all eight of the line items were less than the ACI's
contract base price. The four items were selected based on the
popularity of the equipment. As of June 1991, the ACI contract
contains approximately 211 line items and thus this analysis was
not intended to be all inclusive. The vendor indicated that, in
general, quantities purchased below 50 items may increase the
quoted price up to 10 percent. Quotes from other vendors may vary
in establishing line item prices.
11
-------
Negotiated Amounts Are Significantly Greater Than Actual
Expenses
One of the primary purposes for conducting negotiations in the
absence of price competition is to arrive at an equitable price
for products and services to be purchased. The responsibility to
establish an equitable price rests with the Government and the
contractor. U.S. Code Title 10, Section 2306(a), the "Truth in
Negotiations Act," requires contractors to submit accurate,
complete, and current pricing data,when the head of the Agency
determines that such data is necessary to evaluate the
reasonableness of the price of the contract, and provides a price
reduction remedy when the Government has relied upon defective
contractor data when determining contract prices. Sections
52.215-(22) through (25) of the FAR, incorporated by reference in
the ACI contract, provide a remedy if the contractor furnished
incomplete/inaccurate cost or pricing data, or noncurrent data.
Additionally, section 15.804 of the FAR prescribes "that cost and
pricing data submitted by a contractor enable the Government to
perform a cost or price analysis and ultimately enable [the]
Government and the contractor to negotiate fair and reasonable
prices."
The PPNP identifies the four major contract cost categories —
AOP equipment prices, operating expenses, home office expenses,
and profit. After extensive negotiations, costs related to each
category were determined. For expense items, ratios of costs to
projected contract revenues were computed and factored into the
contract surcharge at fixed percentages. These fixed percentages
were used thereafter as a basis for reimbursement, despite costs
actually incurred by the contractor. Increases and decreases in
ADP equipment costs, operating expenses, or home office expenses
inversely affect ACI's profit.
Negotiated amounts of major operating expense items exceeded the
actual costs incurred by ACI by about $2.4 million over the life
of the contract (see Exhibit A). For example, at full contract
performance, we estimate that 6 of the IS negotiated operating
expense line items are overstated by about $2.27 million (see
Exhibit B). Only one of the items — travel expense — was
understated ($184,006). The remaining 11 operating expense items
had no significant variances. We closely examined variances in
freight and facility rental expenses, which were among the 6
overstated expense items discussed above. Our analysis revealed:
— Freight Expense: The surcharge, per the PPNP, includes a
charge for freight expense equal to 2.5 percent of total
contract sales. Yet, ACI's March 1991, Income Statement
shows freight representing 0.76 percent of contract sales.
At present rates, the freight variance at full contract
performance is projected to total $1.1 million, which
is
-------
represents an amount payable by EPA that will not be
incurred as an expense by ACI. The cause of this variance
is a faulty model by which the surcharged freight expenses
were determined. ACI provided EPA with a model estimating
freight in/out charges for the least costly of nine systems
being provided under the contract. A ratio was computed of
the freight costs to the value of the items being shipped,
and the ratio used in the contract surcharge approximates
the-ratio computed from the model. However, there is no
correlation between freight expenses and the values of
shipped items — costlier items can be transported at nearly
the same cost as the cheaper system used to construct the
model. Surcharge freight expenses should have been based on
the weights of the shipped items. Accordingly, EPA should
have requested additional information concerning freight
charges for the other systems being procured under the
contract. EPA may have identified the need for additional
freight information, and avoided 'added freight costs, if
adequate supervisory reviews had been performed. Further,
EPA procurement officials stated that they lacked experience
in negotiating freight experience.
— Facility Rent Expense: Facility rent costs being recovered
through the contract surcharge total $593,947. During
contract performance, this is equivalent to recovery of
$20,840 per month. This amount was computed based on data
provided to EPA by ACI in January 1990, and was affirmed by
cost analysts in February 1990, and in the PPNP in May 1990.
However, in May 1990, ACI executed a facility rental
agreement that detailed costs of $3,400 per month plus an
unspecified cost for accessory items to outfit the facility.
Our examination of ACI's financial statements revealed that
facility rent is being expensed at $9,061 per month, or
43.48 percent of the amount used to establish the contract
surcharge. Therefore, ACI is realizing excess profits of
$11,779 per month over the life of the contract from
overstated facility rent expense. Had the contractor been
required to certify after executing the rental agreement,
rather than before, excess rental-related surcharge of
$348,318 could have been avoided.
The above deficiencies were caused, in part, by the lack of
sufficient detail in the internal guidance regarding negotiations
of operating expenses. Possible causes for the other four
operating cost variances (equipment, telephone, insurance, and
supplies) valued at $809,948, include:' (a) expenses may have been
improperly recorded; (b) expenses, may have been improperly
valuated; and (c) data presented during negotiations may not have
been current, complete, and accurate. The first two reasons
suggest a deficiency in the contractor's accounting system; the
latter constitutes a violation of the Truth in Negotiations Act,
described previously. We were unable to confirm these causes due
19
-------
to the-lack of a reliable accounting system, and a more detailed
review is required to do so. Other OIG auditors are currently
pursuing this issue in a separate review.
ACI's accounting system was not Government-approved prior to
contract award despite the contracting officer's awareness that
wtACI's] transition from a railroad car/heavy manufacturing
business base to high technology had created some difficulties."
We identified several discrepancies in ACI's financial reporting
to EPA, including: (a) expensing actual warranty costs and
warranty expense accruals in full on income statements without
adjusting accruals for actual costs already expensed; (b)
grouping significant and distinct losses by inventory and cost of
sales together as one expense item; and (c) including the results
of a small but unrelated contract when reporting EPA's interim
workstation contract results. We were unable, because of these
discrepancies, to determine clearly whether accounting errors or
other factors — defective pricing, for example — account for
the remaining variances. These shortcomings suggest that
awarding the contract prior to obtaining Government approval of
ACI's accounting system was an imprudent decision.
RECOMMENDATIONS
We recommend that the Assistant Administrator for Administration
and Resources Management:
1. Issue the competitive contract as soon as possible, but
no later than December 1991.
2. Monitor ADP equipment item prices and renegotiate individual
ACI contract line items that have decreased significantly in
price.
3. Stop buying individual line items if ACI does not make the
equitable price adjustments.
4. Strengthen procedures to help ensure that (a) costs agreed to
during negotiations are based on valid assumptions and
sufficient evidence, and (b) cost and pricing data are
current, complete, and accurate, per the requirements of FAR
15.804-4.
5. Require, as a good business practice, Government-approved
accounting systems for any contractors from which EPA
procures goods and services through a large negotiated firm-
fixed price contract, which allows for renegotiation of
prices.
20
-------
AGENCY COMMENTS AND OIGEVALUATION
In his September 25, 1991, memorandum, the Acting Assistant
Administrator agreed with three of our five recommendations. He
stated that the Agency (a) is working towards a December 1991
award, (b) has requested that ACI review their pricing and submit
revised prices on those line items where the firm has realized
reductions from their suppliers, and (c) will place freezes on
ordering items that they do not believe are fairly priced.
However, he believed that adequate negotiation procedures were
already in place and that the requirement for Government-approved
accounting systems for large negotiated firm-fixed price
contracts was .not necessary (see Appendix 1).
Despite assurances that the procedures are in place, we are
concerned that PCMD did not preclude the variances reported in
Exhibit B. We concur that adherence to FAR procedures alone will
not prevent defective cost and pricing data from being submitted
if that is the vendor's intent. However, we feel that the-
freight variance was preventable had valid assumptions been
employed. Other variances being reviewed, as noted previously,
may also have been preventable.
In addition, we agree that a Government-approved accounting
system for firm-fixed price contracts is not required by law or
regulation. -However, as we have stated previously, to undertake
a contract of this size with a company not previously accustomed
to accounting for large volume ADP acquisitions does not make
good business sense without an approved system. We have
identified several costly deficiencies in this report that
demonstrate the desirability of an approved system, and remain
concerned that management is inclined to assume a significant
risk for large acquisitions.
21
-------
4.
PCMD's FMFIA PROCESS DOES NOT SUFFICIENTLY ADDRESS THE RISKS
ASSOCIATED WITH THE 8 La) PROCUREMENT PROCESS
The Federal Managers' Financial Integrity Act, Public Law 97-255,
requires each executive agency to periodically evaluate its
system of internal accounting and administrative controls and
submit an annual statement of assurance to the President and the
Congress on the status of the agency's system of internal
controls. These evaluations are made pursuant to OMB Circular
A-123. The annual reports are to state whether the systems meet
the objectives of internal control and conform to standards
developed by GAO (Standards for Internal Controls in the Federal
Government. published in 1983). EPA Resources Management
Directive 2560 applies the FMFIA review requirements to
financial, administrative, and program activities at all levels
of the Agency and designates the Assistant Administrator for
Administration and Resources Management as the Agency official
responsible for assuring compliance with the FMFIA, GAO
standards, and OMB guidance. EPA's "Internal Control Guidance
for Managers and Coordinators" provides FMFIA implementation
procedures to Agency officials.
An agency component (i.e., assessable unit) is defined in OMB
Circular A-123 as a major program, administrative activity,
organization, or functional subdivision. EPA guidance requires
5-year Management Control Plans (MCP) which summarize the
Agency's risk assessments, planned actions, and internal control
evaluations to provide reasonable assurance that controls are in
place and working. Assessable units are to include event cycles
(i.e., functional areas within specific organizational
subdivisions). Management Control Plans should be updated
annually and used by management to monitor risk assessment
activities ensuring that scheduled actions actually occur.
Necessary internal control reviews (ICRs) and alternate ICRs
(AICRs) should be listed in MCPs, and should identify internal
controls (i.e., control objectives and techniques) -that need to
be strengthened or streamlined. Based on the results of these
reviews, management should implement required corrective actions
on a timely basis.
As discussed on page 3 of this report, the 8(a) pre-award process
and contract management deficiencies identified in this report
are material weaknesses which meet EPA's materiality criteria for
reporting to the President and Congress in conjunction with OMB
Circular A-123 and the FMFIA. However, these weaknesses were
never identified by PCMD's FMFIA process.
We reviewed the PCMD's 1990 5-year MCP, and found it identified
11 sub-units under the PCMD assessable unit (AU 1204) for which
AICRs were planned. Thirteen AICRs relating to those sub-units
were scheduled for fiscal 1990. No ICRs were planned for that
year. About 13 AICRs are planned for each, fiscal year from 1991
-------
through 1995. No ICRs are planned for this period. Based on
this review we found no on-going or planned AICRs specifically
addressing the 8(a) pre-award process and contract management.
Furthermore, these areas may not get covered in any ICRs planned
in the future, because no event cycles or control objectives and
techniques expressly related to any 8(a) program activities exist
under the PCMD- assessable unit. We also examined PCMD's 1990
Annual Report on Internal Controls and found that no material
weaknesses related to the 8(a) program were ever identified.
In our opinion, the material weaknesses presented in this report
have not been addressed in the FMFIA evaluations. PCMD has not
determined accountability and control over the 8(a) pre-award
process and contract management as high risk activities and thus,
has not (a) included these areas in the event cycles or control
objectives and techniques within the PCMD assessable unit or (b)
scheduled ICRs/AICRs to cover these areas. The PCMD assessable
unit under which these areas should be.included is simply too
broad in scope to facilitate effective assessment of these areas.
As a result the 8(a) program activities do not get the requisite
extent of coverage they deserve under the FMFIA process.
Considering the well publicized problems and scandals of the 8(a)
program and the reasons Congress chose to overhaul the program in
1988, PCMD needs to more adequately address accountability and
control over the 8(a) pre-award process and contract management
within the FMFIA process.
RECOMMENDATIONS
We recommend that the Assistant Administrator for Administration
and Resources Management:
1. Establish an event cycle specific to accountability and
control over the 8(a) pre-award process and contract
management and include the appropriate control objectives
and techniques.
2. Update the risk assessment for the PCMD assessable unit to
more adequately account for the high risks associated with
the 8(a) pre-award process and contract management.
3. Schedule a formal AICR specifically addressing
accountability and control over the 8(a) pre-award process
and contract management in the next MCP.
AGENCY COMMENTS AND PIG EVALUATION
In his September 25, 1991, memorandum, the Acting Assistant
Administrator disagreed with these recommendations. He stated
that: (1) they are the result of an overly broad generalization
of EPA's contracting procedures with 8(a) firms; (2) management
needs to see a greater scope of evaluation before including this
23
-------
issue in their FMFIA reporting; and (3) the problems cited in the
draft report were very contract-specific (see Appendix 1).
The OIG acknowledges that some of the findings in the report are
contract-specific. However, we are concerned that the Agency
does not acknowledge the substantial risks inherent in the 8(a)
program, which have been previously recognized by Congress. This
procurement is the largest active EPA 8(a) procurement, and its
relevance as a representative 8(a) procurement cannot be
dismissed. EPA's intent to increase its involvement in the 8(a)
program creates a demand for additional monitoring of program
resources. The FMFIA process is a cost-effective means by which
internal control weaknesses may be identified. Specific FMFIA
reviews addressing the 8(a) program will best allow EPA to detect
control weaknesses early and to preserve resources.
-------
EXHIBIT A
Page 1 of 3
PROJECTED COST/PROFIT AT FULL CONTRACT PERFORMANCE
Negotiated Projected
Profit—Full Profit—Full Variance
Performance Performance (Percentage! (Dollars)
x
Total Contract
Cost of Equip.
Gross Profit
Operating Exp.
Percentage )
100.00
(83.79)
16.21
(8.59)
( Percentage )
100.00
(71.23)
28.77
(5.03)
12.56
12.56
3.56
$8,483,941
$8,483,941
$2,404,684
Home Office
Expense (2.99) (2.99)
Applicable
Profit 4.63 20.75 16.12 $10,888,625
Adjustments 0 (1.19) (1-19) $(804,023)
Profit 4.63 19.56 14.93 $10,084,602
25
-------
EXHIBIT A
Page 2 of 3
METHODOLOGY FOR EXHIBIT A
Basi,s For Using Full Contract Performance
Projections of cost/profit relative to the ACI contract are based
on the assumption of full contract performance (i.e., .$67.5
million). PCMD officials estimate that $35 million will be
expended on the contract by September 1991. The award of the
competitive workstation contract is currently estimated for
December 1991. We believe that ACI contract could be extended
well beyond the scheduled expiration (December 1991) for the
following reasons:
— ACI is currently the sole supplier of workstation equipment
for EPA until the award of the competitive workstation
contract;
The size and complexity of the competitive workstation
contract requires substantial resources;
— Past estimated award milestones have been overly optimistic;
— Protests—which are typical for large procurements—could
delay the contract award further; and
— Delivery of equipment off the competitive workstation
contract will take a minimum of 85 days after award.
In addition, EPA officials have attempted to expand the interim
contract beyond the $67.5 million. For example, in November
1990, EPA requested an amendment to the original DPA to increase
it by $25 million for an additional 2,000 workstations and 120
local area network servers. However, GSA approved EPA's request
to modify the DPA for the acquisition of the additional
workstations and local area network servers with no increase in
funding (i.e., by reducing procurement of other items in the
contract).
Negotiated Profit Column Explanation
Derived from PCMD's Profit Objective Model and the PPNP.
Projected Profit Column Explanation
— Cost of Goods: We have assumed that the market rate through
March 31, 1991, will remain constant through full
performance.
26
-------
EXHIBIT A
Page 3 of 3
— Operating Expense: To accord with PCMD's Profit Objective
Model, to 60 percent performance, RTP's operating expense
was computed into the surcharge as 100 percent of fixed
costs plus 60 percent of variable costs totaling $4,603,375.
Projecting actual RTP operating expenses through March 31,
1991 to the 60% performance level, we estimate actual
operating expenses of $2,695,652, or 53.56 percent of
negotiated amounts. At full contract performance, this is
equivalent to total operating expenses of $3,398,388, or
5.03 percent of total contract sales estimated at full
performance.
Home Office Expense: This expense is based on projected
home office expenses for full performance per contract
negotiations. • .
Adjustments: Includes costs for which EPA is not paying
through the contract surcharge or by other means, but are
being expensed by ACI. The amounts tabulated below are
extrapolated from expenses accumulated as of March 31, 1991:
Bank Service Charges $ 16,683
Depreciation 43,566
Interest Expense 255,218
Relocation Expense 27,386
Travel > negotiated amts. 184,006
Losses by Inventory 277.164
TOTAL $804,023
Variance Column Explanation
Variance dollars at full performance were computed by taking
the percent variances times the total estimated contract
revenues of $67,547,300 at full performance.
The computations above were based on unaudited financial
statements at December 31, 1990 and March 31, 1991, the PPNP
signed May 10, 1991, and PCMD's Profit Objective Model.
-------
EXHIBIT 8
VARIANCE BETWEEN NEGOTIATED EXPENSES AND PROJECTED
EXPENSES AT FULL CONTRACT PERFORMANCE2
Major
Expense
Item
Facility Rent
Equipment Maint.
& Rental
Freight
Telephone
Insurance
Supplies
Actual
Expense
(3/31/911
$70,937
3,696
147,682
22,489
24,092
43,346
Pro j ected
Expense — Full
Performance
$245,627
12,798
511,365
77,871
33,422
150,091
Negotiated Variance
Amount—Full
• Performance
$593,947 $(348,320)
359,100. (346,302)
1,619,386 (1,108,021)
213,825 (135,955)
309,555 (226,133)
248,084 (97,994)
TOTAL $(2,262,724)
2 Major expense
expenses were taken
items were taken from the PPNP. Actual
from ACI's financial records.. Projected
expenses at full contract performance were computed by projecting
actual expenses as of March 31, 1991, to the total contract amount.
(See Methodology for Exhibit A regarding basis for using full
contract performance.)
28.
-------
EXHIBIT C
CO
|
LJL
O
AFFILIATE
Q
O
C
(QL
< —
C
Own«r
iS
J
o
m
=* o
y s
£ 1
O
\
1
<
I
1
w
*
e
%
* Anthony Welters
# Beatrice Welters
y
1
^
/
\
c^
"^
^^tf
c£=
3
h.
3 |
1 o
J #
* 2
i
r3 C
C |
1 «
^ ^
:= w
(•
=3 O
m
o 0
"c •
m ®
o E 5
. J£ a «
o c
• 00 <0 m
« > 5
OT *-
3 > C
T3 *- O O o
"" a. ® "". ~
« o ^ | »
S £• | 2 1
O flj 5 CO *±
^ c o ?r >
c -2 g w co
2 aj o .S£ o
•- c 5 c ••"
0) O 75 03 O
^ £ "P
-------
Page 1 of S
t UNITED STATES ENVIRONMENTAL PROTECTION AGENCY
I WASHINGTON, O.C. 20440
SEP 2 5 1991
OFFICE OP
AND RESOURCES
SUBJECT: Response to OIG Special Review Draft Report Ho. E6EKFO-
15-0039, Allegations of Improprieties and Management of
the Interim Computer Workstation Contract
FROM: Christian R. Hcjlmes
Acting\aaaistant Administrator
TO: Kenneth A. Konz
Assistant Inspector General for Audit
I appreciate this opportunity to comment on the draft report
prepared as the result of your recent review of the interim
computer workstation procurement. The review focused on
allegations concerning violations of Federal procurement laws and
regulations but also dealt with several procurement management
issues. I am pleased that you found invalid the three
allegations which instigated this special review. However, I am
concerned with some of your other findings and would like to
provide my thoughts and comments.
This review dealt with the 1989-91 procurement of computer
workstations. A portion of this procurement was awarded to an
3(a) contractor, American Coastal Industries (ACI), on July 3,
1990. This contract has now been operational for over fourteen
months and we are quite satisfied with the results. The Agency
has been able to procure all the computer workstations it needs
at reasonable prices and there have been no significant
performance problems with ACI. I am especially pleased that we
were able to award part,of the workstation requirement to an 8(a)
firm.
Your draft report makes essentially six findings. I would
like to give you my comments in the same order in which the
findings are listed.
FINDING 1 - EPA Did Mot Make a Prudent Daeipi,on in Selecting ACI .
The draft report finds that the Procurement and Contracts
Management Division (PCMD):
Printaa an ffacye/M) Psptr
30
-------
APPENDIX 1
Page 2 of 8
1. Old not adequately determine whether ACI was qualified
to perform the contract,
2. Failed to address concerns regarding the adequacy of
ACI'a accounting system, and
3. Should have selected multiple 8(a) contractors for award
rather than make a single award.
See APPENDIX - The selection of ACI to perform the contract was made in
N'ote 1 accordance with standard a (a) procurement procedures. Several
possible contractors identified by EPA's Office of Small and
Oisadvantaged Business utilization were considered by a PCHO and
National Data Processing Division (NDPO) panel. Two were
selected to provide a customary '•marketing" presentation to the
panel which then contacted references and visited each of the
firms' technical sites under previous contracts. EPA selected
ACI because of the latter's strong management team and its
proposed project manager's experience running a computer
manufacturing contract. EPA then requested permission from the
Small Business Administration (SBA) to negotiate a contract with
ACI. This permission was granted in September, 1989.
See APPENDIX 2 Subsequent to that action, SBA had internal disagreements
Mote 2 over whether ACI was capable of performing the contract. Our
review of the firm's qualifications provided us with sufficient
confidence to pursue the award. Clearly, had there been
significant doubts, PCMD would have searched for another
contractor. It is important to note that SBA did finally resolve
its internal differences and authorized ACI to perform the work.
Also, ACI has performed well under the contract, thereby
underlining the appropriateness of EPA's choice.
See APPENDIX 2 the draft report states that PCMD "ignored" concerns
Mote 3 expressed about the adequacy of ACI'a accounting system. That
simply is not true. Any decision on the criticality of an
accounting system weakness is one of "contractor responsibility"
which must be made by the contracting officer. Such a
determination is taken very seriously and is usually made only
after seeking and evaluating expert advice. In this case, the
contracting officer worked closely with EPA's cost advisory
office which is staffed with accountants who are experienced in
these matters. Based on 'the advice of that office and the
contracting officer's own judgement, it was determined that ACI's
accounting deficiencies were not material enough to prevent
satisfactory performance. Again, I would like to point out that
SBA came to the same conclusion as EPA.
See APPENDIX 2 The draft report also suggests that EPA should have selected
4 multiple 3(a) firms that demonstrated competency in computer
manufacturing rather than awarding only one contract. Decisions
on how to conduct a procurement are made only after weighing a
31
-------
Page 3 of 8
See APPENDIX 2
Mote 5
See APPENDIX 2
Note 0
variety of factors and are not made lightly. Issues that are
considered in these cases are the cost effectiveness of one award
vs. multiple awards, problems that might be associated with the
compatibility of equipment provided by different contractors, the
nature of contract start-up costs and other fixed expenses, risk
to EPA, and the Agency's ability to effectively procure and
manage multiple contracts. The use of multiple 8(a) contracts
was not practical in this situation.
FINDING 2 • The Interim Contract Award to ACT Goea Beyond the
Intent of the Bta.) Program
The draft report raises issues regarding ACI's 3(a) status
and EPA's decision to award one 3(a) contract vs. making multiple
3(a) awards. First, it is not within EPA's purview to determine,
in lieu of SBA, whether a firm is eligible under the 8(a)
program. EPA must rely on the SBA for their expertise in this
area. ACI met all the criteria for inclusion in the program.
Second, as we addressed in the previous finding, although we
would certainly like to broaden our cadre of a(a) contractors, it
was not practical for EPA to make multiple contract awards. We
will, though, continue to look for new ways to include more 3(a)
firms in our contracting programs.
FINDING 3 - Pelav InAwarding the Competitive Contract Will Cost
EPA^tilliana at Dollars
This finding refers to the fact that, concurrent with the
8(a) procurement, EPA. was also conducting a fully competitive
procurement for computer workstations. Because of an unexpected
surge in demand, quantities under our existing contract vehicle
had been depleted a year ahead of schedule. Also, because it was
going to take longer than originally anticipated to award the
fully competitive contract, a management decision was made to
procure part of the workstations under the a(a) program. The
Agency was facing a critical need for computer workstations which
would not be met without taking this approach. Contract awards
under the 8(a) program tend to take less time to process and can,
therefore, more quickly address a critical need while benefitting
diaadvantaged businesses.
The draft report state* that because of the delay in
awarding the competitive contract, EPA is paying millions of
dollars of excess costs under the contract with ACI, the primary
logic being that prices under full and open competitions tend to
be lower. The actual prices under the ACI contract are dealt
with in a subsequent finding; this portion of the draft report,
however, focuses on a perception that EPA management is not
making completion of the competitive procurement a sufficiently
high priority.
32
-------
Arr'L.i-iUJ.A i.
Page 4 of «
See APPENDIX 2
Note 7
See APPENDIX
3
See APPENDIX :
I an concerned that this perception exists. It is
unfortunate that the competitive procurement is talcing longer
than originally anticipated. However, the delay is not of the
magnitude suggested in the draft report. The OZG conclusions are
based on its review of an initial optimistic schedule that was
later realistically refined to reflect the complexities
associated with this sort of procurement, there are many factors
that can impact the award of a contract, not the least of which
are protests and competing requirements. . PCMD must make
decisions regularly on the best way to manage its resources based
on the workload it carries.
I also question the statement that it will cost the Agency
$8.4 million as the result of the delay. It is important to note
that PCMD was able to provide EPA with the ability to obtain
computer workstations through the ACT vehicle. The other option
was that there would be no contract vehicle in place for at least
another year, since the ACI award had little effect on the delays
experienced on the competitive procurement. EPA would not have
had anY access to the computer workstations it so critically
needs to carry out its mission. Costs in this case would have
been significantly greater and, more than likely, could not be
measured in dollars. This procurement must be put into proper
perspective.
FINDING 4 - Better Administration of the AC! Contract Could Avoid
Some Coats
This finding addresses the OIC's concern that EPA is paying
$8.4 million in excess costs as the result of using the ACI
contract. This figure is based on the difference between the
negotiated equipment prices and the actual cost of those same
items at the time of the QIC audit, approximately one year later.
Although PCMD negotiated fair prices for items at the time of
award, the technology being procured evolves at a rapid pace.
Thus, the contract negotiated prices may drop over time until the
individual items are changed to newer technology through the
contract's various upgrade clauses. It is through this constant
stream of upgrades, continually bringing the contract price of
items and the market price together, that EPA attempts to keep
pace with this issue.
The draft report also identifies four sample items that were
analyzed by your office with the resulting determination that
they were overpriced by about $2.7 million. The analysis used in
the draft report involved comparing ACI'3 prices with that of a
single major retail vendor involved in Government contracting.
We performed the same sort of analysis and compared the same ACI
item prices to GSA schedule prices, mail order house prices, and
a volume purchase quote. In obtaining our quotes, we ensured we
were using the same brand name specifications rather than similar
generic items. We also verified the period of time which the
-------
Page 3 of 8
quote covered, the potential quantities being ordered without a .
guarantee o£ purchase, the delivery schedule, and other special •
terms and conditions of the ACI contract. In most cases, the ACI
prices were the least expensive, resulting in savings of
approximately $650,000.
See *PPE\DI" 2 Another part of this finding is that PCMD, in administering
« r i VJ.A the ACI contractf does not use the various contract mechanisms
Elote 10 available to it, to ensure the lowest possible costs. We take
exception to this conclusion. PCMD is not remiss if it does not
renegotiate the fixed prices downward any time that an item is
found at a lower price on the open market. That does not follow
the philosophy of a fixed price contract — such as this one with
ACI — where a vendor may lose or gain on various aspects of the
job.
The Engineering Changes clause quoted in the draft report is
to be used to change equipment on a contract to different
upgraded equipment. It is not to be used to renegotiate the
price of items already on the contract. This special clause, and
several others in the contract, were designed to enable EPA to
benefit from new, faster machines and improved software. To
date, we have over fifty changes to contract line items either
already incorporated into the contract or in process. Although
many of these were initiated by ACI as required by the contract,
a substantial number were also the result of close EPA
management.
See APPEHDIX 2 Additionally, the draft report suggests that if quantities
.. , I " for a particular line item are increased, there should be an
•Moce LI. automatic reduction in price. Since the ACI contract is an
Indefinite Delivery /Indefinite Quantity type, the contractor does
not necessarily benefit from volume buying from its suppliers
because none of the quantities is guaranteed. Thus, there is no
reason to expect an automatic decrease in price.
See APPENDIX 2 As the result of our recent reexamination of the contract
note 12 pricing, we are confident that the prices negotiated with ACI are
fair and reasonable. They compare favorably with the
marketplace. Additionally, although there is always room for
improvement, I believe that EPA personnel are performing
effective contract management in ensuring continued price
reasonableness.
FINDING 5 — Negotiated Amounts Are Significantly Greater Than
Actual Eacaenaea
See APPSUDi:: 2 Xhis portion of the draft report focuses on cost areas where
Mote 13 it appears that the amount of money EPA is paying ACI is
substantially higher than the expenses the firm is incurring. As
a result, the draft report notes the potential for excess
profits. The discussion highlights freight and facility rent
34
-------
r
APPIMDIX 1
Page 6 of
See APPENDIX 2
llote 14
f See APPENDIX 2
Note IS
See APPI:::DI:: 2
!Jote 16
See APPCt.'DIX 2.
Mote 17
expenses, although the report indicates that there are four other
overstated expense line items.
In the case of freight, rather than performing a detailed
analysis of each item, ACI proposed applying a ratio of the
estimated freight cost to the negotiated hardware price of a
single item, the GRID PC, across the board. Although this method
was not as detailed as performing a more in-depth analysis, the
contracting officer's judgement at the time was that the rate was
reasonable. As a result, that approach was accepted. In,
retrospect, perhaps an iteo-by-item negotiation would have been
better. Even so, ACI may well not garner excess profits because
when ordering ceases under the contract, losses aay well be
experienced in other areas.
/
In the cas* of rent, ACI signed a lease at less than half
the cost: negotiated with EPA within a month of contract
negotiations and prior to award. It appears that there may have
been a violation of the Truth in Negotiations Act, which would
allow recovery of the excess costs. We request the OIG to
vigorously pursue an investigation into the possibility that ACI
provided defective pricing-data.
It is important to note that all of the auditor's
calculations regarding excess costs that the Government might pay
are based on the presumption that EPA will purchase the full
$67.5 million contract value. This is an invalid assumption. We
project that the value of the contract at completion in December,
1991 will be only $35 million based on usage to date. As a
result, the higher profits earned on expenses such as freight and
rent will be counter-balanced by losses on other fixed expenses.
Similarly, lower total usage of the contract will significantly
reduce the magnitude of ACI'a earnings.
FINDING 6 — PCXP'g FMF|A Process Does Not Sufficiently Address
chg ftialca Associated with t;he9 fa) Procurement Proqess
This finding suggests that the allegations made in the draft
report are substantially significant and broad-based enough to
require special control measures and tracking within the Federal
Managers Financial Integrity Act. . We suggest that this is an
over-reaction to isolated procurement issues. The findings made
in this draft report are primarily contract-specific. They deal
with our decision to use ACI, perceived delays associated with
one set of procurements, contract administration of the ACI
contract, and ACI's accounting system.
We are very much aware that contract management, in general,
is an Agency .vulnerability. EPA's broad use of contractors and
the considerable scrutiny EPA's contracting programs receive
underline the importance of good contract management. However,
to stretch this one study into an Agency-wide weakness is a major
35
-------
Page 7 of 3
leap that the report does not justify.
QIC endationa ano^ OAHM Responses
1. Issue the competitive contract as soon as possible, but not
later than December, 1991.
OARM understands the significance of awarding this contract
and is working towards a December, 1991 award.
2. Monitor the ADP equipment market prioes and renegotiate
individual ACX contract line items that have decreased *
significantly in price.
Because of the fixed price nature of the ACI contract, PCMD
has no legal right to a lower price. It should be noted that f
when the price of contract items significantly drops, it is v
usually caused by the availability of new items with better price
to performance ratios. We currently monitor this and will
continue to do so. We have already replaced more than fifty
items to take advantage of these changes in technology.
Additionally, PCMD has recently sent a letter to ACI requesting
that they review their pricing and submit revised prices on those
line items where the firm has realized reductions from their
suppliers.
3. Stop buying individual items if ACX does not msJce the
equitable price adjustments.
There is presently a "hold" on one item, the Postscript
printer, based on its excessive price. As we have in the past,
we will closely monitor prices and place additional freezes on
ordering items that we do not believe are fairly priced.
4. Establish and implement procedures to ensure that (a) costs
agreed to during negotiations are based on valid assumptions
and sufficient evidence, and (b) cost and pricing data are
current, complete and accurate, per the requirements of FAH
15.804-4.
PCMD already has such procedures in place; they are
fundamental to any federal contracting organization. Contract
agreements are reached based on the best information available
and the most informed contracting officer judgements. We would
not award a contract if we felt there were significant
unrasolvable problems. It should be noted, though, that merely
following the FAR procedures will not prevent defective cost and
pricing data from being submitted if that is the vendor's intent.
Additionally, adhering to the FAR requirements does not mitigate
any effects of subsequent changes in the marketplace which reduce
prices. ""
36
-------
APPENDIX L
Page U of a
S. Require, as good business practice, Government-approved
accounting systems for any contractors from which EPA
procures goods and services through a large negotiated firm
fixed price contract, which allows for renegotiation of
prices.
Although we agree that having an acceptable accounting
system is desirable, it is not mandatory by lav or regulation for
this type .of contract. ACI's estimating and accounting systems
were analyzed by EPA and, in the contracting officer's judgement,
were determined adequate to enable the Government to reasonably
estimate prices. Further, mandatory renegotiation of prices
under fixed price contracts is not allowable unless defective
cost and pricing data have been employed.
> ». Establish an event cycle specific to accountability and
control over the a(a) pre-award process and contract
management and include the appropriate control objectives
and techniques.
7. Update the risk assessment for the PCMD assessable unit to
more adequately account for the high risks associated with
the .8(a) pre-award process and contract management.
a. schedule a formal Aica specifically addressing
accountability and control over the 8(a) pre-award process
and contract management in the next MCP.
We believe that the last three recommendations are the
result of an overly broad generalization of EFA's contracting
procedures with 8(a) firms. Prior to including this issue in our
FM7IA reporting, we need to see a greater scope of evaluation.
Most of the problems cited in this draft report are very
contract-specific.
We would like to note that negotiating any large dollar
value contract has a certain element of risk. PCMD has
established a rigorous pre-award review process that considers
the risk, regulations, and programmatic needs in selecting
contractors for the Agency. We feel that, in the instance of
ACZ, these procedures functioned well. .We will, however,
continue to closely monitor a(a) awards and the contract
management function to ensure that they continue to operate
effectively.
i
Thank you again for giving us the opportunity to respond to
your draft report. Should you have questions regarding the
content of this response, they should be directed to David J.
O'Connor, Director, PCMD.
37
-------
APPENDIX 2
Page 1 of 7
ADDITIONAL QIG COMMENTS TO SEPTEMBER 25. 1991
RESPONSE TO DRAFT AUDIT REPORT
The following notes present the QIC's response to the Office of
Administration and Resources Management's (OARM) comments which
were not addressed in the body of the report.
Note;
•v
1 OARM stated that they considered several possible
contractors. However, we were unable to find in PCMD's pre-
award files any documented consideration of any contractors
other than ACI and Automated Data Management, Inc.
Furthermore, PCMD and NDPD officials were unable to identify
the names of any other contractors considered.
OARM stated that ACI was selected for its "strong
management'* team. However, according to PCMD pre-award
files, the one independent reference (the contracting
officer for ACI's "Sea Shed" contract with the Navy) stated
that he "would not totally endorse (ACI) management, don't
know (their) expertise in other areas." PCMD based their
"strong management*' conclusion, primarily, on interviews
with officials from Healthcare Management Alternatives, Inc.
— a company whose Chairman of the Board is ACI's owner.
Furthermore, the project manager selected for ACI's EPA
contract was formerly the Systems Management American
Corporation (SMA) project manager for EPA's contract with
SMA ~ a company which has been repeatedly criticized by
PCMD and NDPD officials for poor performance.
2 OARM stated that SBA had internal disagreements over whether
ACI was capable of performing the contract. According to
our review of SBA files, the SBA Washington District Office
disapproved the EPA/ACI contract because ACI (a) did not
qualify under the computer manufacturing SIC Code and (b)
had a poor financial rating. Subsequently, SBA's Region III
Administrator overruled the SBA Washington District Office,
primarily because of the District Office's 8-month delay in
"...bringing these issues to the table..." This is not
evidence that SBA "resolved its internal differences," as
OARM maintains. In fact, subsequent to the Regional
Administrator's approval of the contract, the District ;.
Director, wrote to her stating "I have reviewed (the Regional
Office's position), and I am still of the opinion that the
contract should not be signed." „
-------
APPENDIX 2
Page 2 of 7
OARM stated that its review of the firm's qualifications
provided sufficient confidence to pursue the award. How-
ever, we found no evidence in the PCMD pre-award file that
supported the conclusion that ACI had the qualifications or
the financial stability to perform the contract. In fact,
as stated in the report, we found significant evidence to
the contrary.
OARM stated that based, in part, on the advice of EPA's cost
advisory office it was determined that ACI's accounting
deficiencies were not material enough to prevent
satisfactory performance. However, based on the Washington
Cost Advisory Operation's March 2, 1990, letter to the
contracting officer, the cost advisory auditor determined
that ACI's "...financial capability to perform under the
subject contract is in question'* and that "...EPA and ACI
are put in a high risk situation which is not cost
effective." In our opinion, the advice of EPA's cost
advisory office was clearly ignored. Further, a senior PCMD
official advised us that he had been very concerned that
ACI's poor financial condition would adversely affect their
ability to carry out the contract.
OARM stated that issuing multiple 8(a) awards (a) was not
cost effective, (b) was a higher risk, and (c) would pose
equipment compatibility problems. However, a small number
of lower dollar contracts may have been more cost effective
than the ACI contract. SBA provided us a recommended list
of 25 8(a) firms with the 3571. SIC Code (i.e., computer
manufacturing) which were capable of providing the similar
products and services to Federal agencies and private
industry companies. Therefore, these companies, which were
already established and doing business, would not incur
additional start-up costs and other fixed expenses.
Additionally, the procurement and management may be
substantially less for smaller contracts. According to PCMD.
officials and documentation in the PCMD pre-award files, the
management of the ACI contract was a substantial burden
because of its size. Furthermore, the Agency would be able
to obtain substantially better prices for products and
services from multiple firms.
*
Regarding the risk, ACI clearly was the higher risk for non-
performance than the SBA recommended firms, because the SBA
firms were already in the business and financially stable.
As a result, the Agency has had to pay substantially higher
than market prices to ACI to eliminate that risk.
39
-------
APPENDIX 2
Page 3 of 7
Regarding the equipment compatibility problems with multiple
firms, according to PCMD, even though the contract was
product specific many upgrades and substitutions have been
made. In fact, compatibility problems have occurred with
the ACI contract. Therefore, the compatibility risk would
have been the same in either case. If the Agency was
seriously concerned about compatibility problems, the terms
of each contract could have been written to substantially -
reduce that risk.
OARM stated that it is not within EPA's purview to
determine, in lieu of SBA, whether a firm is eligible under
the 8(a) program. In this case, we believe it was a shared
responsibility because: (a) EPA strongly recommended ACI to
SBA; (b) EPA is the .ultimate customer of the 8(a) contractor
and has a vested interest and responsibility to ensure
performance of a contractor supporting its mission; and (c)
EPA has a fiduciary responsibility to ensure that the
taxpayers' dollars are properly spent.
Management is not making the completion of the competitive
award a sufficiently high priority based on available
procurement records and comments of several procurement
officials. PCMD officials told us and documented the fact
that the supercomputer procurement took priority over the
award of the competitive workstation contract. Furthermore,
PCMD officials told us that there has been no incentive to
issue the competitive contract since ACI was in place.
Thus, we fully support the statements in the report that the
competitive workstation award was not a sufficiently high
priority. Since we have brought this to management's
attention, PCMD has assured us that the competitive award is
being given the highest possible priority and is expected by
.December 1991.
The 19-month delay in the report is valid and, in fact,
could be considered a conservative estimate. At the onset
of the competitive workstation procurement, an initial
schedule was prepared showing the milestone dates. No
detailed explanation of the basis for the schedule existed
at that time to support the award target date and thus, we
relied on that schedule for our analysis. PCMD's current
schedule to award the contract in December 1991 only
provides for initial award of the contract. There may be
more unforseen problems such as additional protests. Also,
the current schedule totals 33 months to make the contract
award. Procurement officials recently told us that most
40
-------
APPENDIX 2
Page 4 of 7
agencies take about 44 months for this type of award.
Consequently, the delays from the original schedule could be
in excess of the 19 months.
3 ADP equipment prices decrease for reasons other than newer
technology which are not being addressed by the contract
modification process. For instance, price decreases can
occur because of (a) discounts due to quantity increases on
the contract, (b) competition from other vendors in the
market, and (c) competition of comparable equipment.
Quality and compatibility are not dictated by a specific
brand name of the machine. The microcomputer industry is
becoming a commodity marketplace where significant amounts
can be saved by concentrating on comparability and quality,
not brand names. Our table showing the 4 items is an
example of prices that have changed because of these
factors. PCMD has not provided the constant stream of
upgrades over the full life of the contract, but has instead
increased its efforts in this area after June 1991.
9 The response indicates that PCMD performed the same sort of
analysis and compared the same ACI contract prices. In
fact, their analysis only included 3 of the 4 items (i.e.,
it did not include the color monitor). Also, their analysis
showed that ACIfs Postscript Laser Printer price was above
the July 1991 market price. Thus, only 2 of the 4 items
contributed to the conclusion that the ACI price was less
expensive than the market. Further, we considered all
relevant factors (e.g., we provided the vendor with contract
specifications) when obtaining our quoted prices.
10 We agree that PCMD could not unilaterally adjust fixed
contract prices. We believe that EPA should have attempted
to renegotiate prices or simply stopped buying various items
off the contract. In addition, before exercising the
contract options, the contracting officer is' required by the
FAR to determine that prices were better than prices
available in the market. If ACI were not willing to
negotiate lower prices, a second 8(a) contract could have
been negotiated with another firm or alternative sources
could have been found.
11 Contract prices would not automatically be decreased without
renegotiation. Individual line item prices at the onset of
the ACI contract were guaranteed, even though it was an IDI.Q
contract. Some of the line items are being increased by
large quantities. For example, the basic MS-DOS/OS2 system
original quantity was only 800, but after several
li
-------
APPENDIX 2
Page 5 of 7
modifications the quantity has increased to 2,970. In these
cases, because of the significant increased quantity, we
feel that a price decrease is warranted and lower prices
could be negotiated with a vendor. One vendor indicated to
us that their policy was to allow about a 10 percent
decrease if more than 50 items are purchased. In addition,
contract modifications making major quantity changes should
not be common and significant changes in quantities made
only with sufficient justification.
12 The ACI contract prices are not fair, reasonable, or
comparable to the market. ACI is experiencing an excess
profit of about 15 percent which is directly attributable to
decreases in hardware and software prices. There are
comparable ADP equipment items available at significantly
lower costs that could be purchased through alternative
means or by amending the contract.
The industry has had an unprecedented decline in micro-
computer prices. Standardization and interchangeability
have resulted in substantially lower prices without
sacrificing quality or compatibility. Major companies have
had to lower prices to meet the realities of selling against
commodity microcomputers in a tight market. Other Federal
agencies are taking advantage of lower market prices. For
example, lower prices on a Navy standard desktop contract
scheduled to be effective in October 1991 were accelerated
so that they were effective in August 1991. We believe that
PCMD should take advantage of the current market and
eliminate wasteful expenditures.
13 0ARM'S response observes correctly that freight and facility
rent expenses are highlighted in the discussion of excessive
expenses. Four other expense categories are identified for
which amounts surcharged significantly exceed actual costs
being incurred by the contractor. The causes for these
excesses are being reviewed by other OIG auditors. EPA will
be advised of the results of the review when it is
completed.
14 In the case of freight, EPA acknowledges that an item-by-
item negotiation may have been better. Since freight
expense singularly accounts for over 20 percent of
surcharged expenses under the contract, and nearly half of
the variance projected in Exhibit B, we feel item-by-item
negotiation was essential in this instance. The implicit
suggestions of ACI's freight model are that: (a) the GRID
42.
-------
APPENDIX 2
Page 6 of 7
freight pricing presented was representative of the costs
for all systems being procured under the contract; and (b)
there is a direct correlation between freight costs and the
prices, rather than the weights, of items shipped. These
suggestions are clearly untrue.
We disagree that ACI "may not garner excess profits because
when ordering ceases under the contract, losses may well be
experienced in other areas". Through March 31, 1991, ACI
had already recorded over $2.4 million dollars in net income
from the Interim Workstation Contract from only' $19.5
million sales. The profit objective at full performance,
$67.5 million sales, is $3.1 million. ACI had already
expensed $1.52 million in home office expenses, leaving only
$.09 million to recover in home office expenses (which we
believe has already been recovered). Since fixed RTP
facility expenses are being recovered in an accelerated
manner similar to that authorized for home office expenses,
the amount of RTP expenses applied to future sales will also
decline. Sales as of September 15, 1991, exceed $31
million. If ordering ceases immediately, and even if one
applies all of ACI's after-contract expenses against income,
ACI will still have realized excess profits under the
contract.
15 Other OIG auditors had begun a review of the potential
defective pricing issue before our draft report was issued.
16 We concur that our calculations are based on full contract
value for the reasons stated in Exhibit A. We also agree
that lower total usage will reduce ACI's profit realization
under the contract. EPA projects revenues of only $35
million for this contract based on usage to date, presuming
the contract will be completed in December 1991. This
appears optimistic, given current buying trends; sales
already exceed $31 million, and the results of another
quarter must be considered. However, we agree that the
validity of any assumption concerning total sales is subject
to uncertainty. We forecast excess profits at $35 million
sales at $4.1 million, almost $6.0 million less than
forecasted excess profits at full performance. This
supports our contention that awarding the competitive
contract as soon as possible is desirable, and we encourage
EPA's efforts to expedite competitive award.
43
-------
APPENDIX 2
Page 7 of 7
17 EPA's response suggests that the report findings are
contract-specific, and that this FMFIA finding is an
overreaction to isolated procurement issues related to just
one contract. We agree that our review, initiated to
resolve severe allegations made against the contractor in
its capacity as an 3(a) firm, relates to one contract.
However, this procurement is easily the Agency's largest %
active 8(a) procurement, and to dismiss its importance as
evidence of Agency-wide weaknesses is inappropriate.
Further, while contract administration and accounting .<•
systems are contract-specific matters, the events related to
contract award and the size of the contract are critical
8(a) procurement issues. If EPA intends to become a more
active participant in the 8(a) program, as management has
indicated, then EPA should place added emphasis on
monitoring its 3(a) resources. Since the FMFIA process is
designed to detect material internal control weaknesses in a
cost-effective manner, it is essential that it encompass all
areas to which the Agency devotes significant resources. In
this regard, we consider it most important that EPA's FMFIA
process include specific review of 3(a) procurements.
14.
-------
APPENDIX 3
DISTRIBUTION OF REPORT
Inspector General (A-109)
Acting Assistant Administrator for Administration
and Resources Management (PM-208)
Comptroller (PM-225)
Agency Followup Official (PM-225)
Attn: Director, Resource Management Division
Agency Followup Official (PM-208)
Audit Followup Coordinator (PM-208)
Attn: Program Operations Support Staff
45
-------
-------