United States General Accounting Office

GAO Report to the Ranking Minority Member,

Committee on Commerce, House of

Representatives

May 1996 DEFENSE

PROCUREMENT

E-Systems’ Reporting

of Alleged Wrongdoing

to Army’s Fraud

Division

G O A

years

1921 - 1996

GAO/OSI-96-6

GAO United States

General Accounting Office

Washington, D.C. 20548

Office of Special Investigations

B-265783 

May 16, 1996

The Honorable John D. Dingell

Ranking Minority Member

Committee on Commerce

House of Representatives

Dear Mr. Dingell:

After E-Systems, Inc., a defense contractor, pleaded guilty in July 1990 to

violations of federal law related to contracts with the Department of the

Army, the Army entered into a 3-year administrative settlement agreement

(Memcor Agreement) with the company. Among other things, the

agreement required E-Systems to report all hotline1

 allegations to the

Army’s Procurement Fraud Division. When the Subcommittee on

Oversight and Investigations, House Committee on Energy and Commerce,

received allegations from a former chief investigator for E-Systems’

Greenville (Texas) Division concerning the division’s hotline/ethics

program, you, as the Subcommittee’s then Chairman, asked us to answer

the following questions.

• Did federal law, regulations, or the Memcor Agreement require E-Systems

to disclose suspected violations of procurement law?

• How many and what types of hotline complaints were lodged against

E-Systems’ Greenville Division?

• Did E-Systems’ employees, contrary to federal law, alter or reinvestigate

hotline complaints and investigation results to avoid disclosing

information to the federal government; and what were the details behind

three cases that had been brought to the Subcommittee’s attention?

• Why did the Army not debar E-Systems from doing business with the

government, given the serious accusations contained in a May 1994 Army

“show cause” letter?

• What loss did the government experience as a result of E-Systems’ actions

in the three previously mentioned hotline cases?

Results in Brief Although federal laws and regulations did not require E-Systems to report

suspected violations of procurement law to the government, the

August 1990 Memcor Agreement, and a later second administrative

agreement, required the company to do so, as did its Standards of Business

Conduct and Ethics.

1

Under the Defense Industry Initiative on Business Ethics and Conduct, E-Systems established a

hotline in June 1987.

Page 1 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
B-265783 

During the period covered by the Memcor Agreement (Aug. 1990-Aug.

1993), E-Systems’ Greenville Division reported that 202 cases regarding

hotline complaints had been opened or closed. All were reported to the

Army’s Procurement Fraud Division. Of the 202 cases, 83 (about

41 percent) related to alleged wrongdoing in federal contracts; the rest,

management and employee-relations issues. From the start of a second

administrative agreement in July 1994 through November 1994, the latest

date covered by our investigation, E-Systems opened and reported three

hotline cases; one dealt with procurement law violations.

In its quarterly reports to the Army, required by the Memcor Agreement,

E-Systems did not report the findings of wrongdoing for one of the three

hotline cases that were the focus of the allegations to the Subcommittee.

The E-Systems reports included inaccurate information or omitted

relevant facts about the other two cases. Information about these

wrongdoings—including making false claims and falsifying

documents—was contained in the hotline investigator’s reports. The

Defense Logistics Agency (DLA), in its 1994 review of E-Systems’

compliance with the Memcor Agreement, generally concurred with the

hotline investigator’s reports. We found no evidence that E-Systems had

altered internal investigation reports or reinvestigated hotline complaints

to avoid disclosing information to the federal government.

Following that 1994 review, DLA reported that E-Systems had violated the

Memcor Agreement. However, E-Systems’ violations did not merit

debarment,2

 according to the Chief, Army’s Procurement Fraud Division,

because the Army did not have sufficient evidence to prove that E-Systems

had intentionally withheld information from the government.

Nevertheless, in July 1994, the Army entered into a second administrative

settlement agreement that required E-Systems’ reports to the Army to

provide more detailed information about each allegation and its resolution

than did the first agreement.

A potential loss to the government occurred in at least one of the three

hotline cases that we examined. The Defense Contract Audit Agency

(DCAA) estimated that E-Systems’ actions may have cost the government

about $228,000, resulting from mischarged labor hours.

2

“Debarment” is excluding a contractor from government contracting for a reasonable, specified

period of time, generally not to exceed 3 years. FAR 9.406-4(a). “Suspension” is temporarily

disqualifying a contractor from government contracting for up to 18 months unless legal proceedings

are initiated during that period. FAR 9.407-4. A contractor found guilty of violating procurement law or

an administrative settlement agreement faces possible suspension or debarment action.

Page 2 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
B-265783 

Background As a result of numerous reports of questionable procurement practices by

defense contractors, in 1986 the President’s Blue Ribbon Commission on

Defense Management (Packard Commission) recommended contractor

self-regulation to strengthen accountability in lieu of increased federal

legislation and oversight. To implement the recommendation, a number of

Department of Defense contractors adopted the Defense Industry

Initiative on Business Ethics and Conduct (DII).

Under DII, signatories commit to a written code of business ethics and

conduct, create a free and open atmosphere that encourages employees to

report violations to the company without fear of retribution, and monitor

compliance with federal procurement law. They also commit to voluntarily

report procurement violations and corrective actions to the appropriate

federal agency. In a July 1986 letter, the Deputy Secretary of Defense

encouraged all defense contractors to report potential criminal matters to

the Deputy Inspector General, Department of Defense, and report

potential noncriminal matters to DCAA or the appropriate contracting

officer. Since DII is a voluntary disclosure program, federal agencies

cannot initiate enforcement action for noncompliance with DII’s principles.

On July 3, 1986, E-Systems signed DII—one of the first companies to do so.

To comply with DII, each E-Systems division, including the Greenville

Division, established an Ethics Hotline for employees to report suspected

violations of federal procurement law, an Ethics Program Director to

direct internal investigations of hotline cases, and a senior-level

management Ethics Committee.

After E-Systems pleaded guilty in July 1990 to three counts of false claims

and conspiracy committed by its Memcor Division in Bushnell, Florida,

(1) E-Systems provided the Army a compliance plan to ensure that failures

to comply with federal procurement law would not recur; and (2) the

Army, in August 1990, entered into a 3-year administrative settlement

agreement with E-Systems (Memcor Agreement). The agreement, which

included the compliance plan, required E-Systems to report all hotline

allegations and their resolution to the Army’s Procurement Fraud Division.

Page 3 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
B-265783 

E-Systems Did Not

Abide by Its Own

Requirement to

Report Suspected

Violations and Did

Not Fully Detail

Violations Under the

Memcor Agreement

E-Systems’ Own Reporting

Requirements Not

Followed

Federal law and regulations did not require E-Systems to report suspected

violations of procurement law to the government. However, as a DII

signatory, E-Systems has committed—but is not required—to implement

six principles of business ethics and conduct, including those that relate to

the disclosure of procurement law violations to the federal government.

Although E-Systems’ own Standards of Business Conduct and Ethics

required the company to report suspected violations to the appropriate

government agencies, E-Systems did not begin to formally report

suspected violations to the government until required to do so in

August 1990 by the Memcor Agreement.

E-Systems officials told us that “where issues of potential significance

were identified, notification to the government did occur” outside the

timeframes of the Memcor and second administrative agreements.

However, the experiences of the government agencies that should have

received such reports differed. E-Systems’ lack of disclosure was

evidenced by a DCAA audit report and the experiences of DCAA

representatives, the Defense Plant Representative Office,3 and the

Department of Defense Office of Inspector General (OIG).

3

E-Systems specifically identified a former Commander of the Defense Plant Representative Office

who, according to E-Systems, had been briefed on November 1, 1988, on a hotline case. Although the

Defense Plant Representative Office has no record of the issue, the former Commander told us he

recalls the issue but not its details. According to the former Commander, he trusted E-Systems to

protect the government’s interests in such cases. He said that because he had been at E-Systems only a

month on November 1, his former Deputy and Chief of the Contracts Division would have been

included in any formal meeting with E-Systems and would be the best source for follow-up action on

the issue. However, that individual told us that he had not been made aware of the allegation, as such

an issue would normally have been referred for further inquiry to the Defense Investigative Service

(now the Defense Criminal Investigative Service) or to the Department’s legal department.

Page 4 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
B-265783 

Alleged Violations Not

Fully Detailed in

E-Systems’ Reports Under

Memcor Agreement

Although the Memcor Agreement required E-Systems to provide the Army

quarterly reports of all hotline cases and their resolution, the agreement

did not specify the level of detail that E-Systems should use in the reports.

The Army agreed that E-Systems would provide it with copies of quarterly

reports made to the company’s Audit Committee. According to E-Systems’

compliance policies, these reports to the Audit Committee would ensure

“a high level of review and oversight.” The reports did not, however,

contain the level of detail that the Army had expected.

For example, an April 1994 DLA compliance review concluded that

E-Systems’ quarterly reports “did not always depict the allegations

accurately” and did not “necessarily depict the findings of the

investigator.” The Army concurred with DLA’s findings and in July 1994

entered into a 2-year administrative agreement with E-Systems. This

second agreement required E-Systems to modify its quarterly reports so

that the Army would receive a copy of the hotline allegations, the status of

the investigation, and the investigation’s findings and conclusions.

Number and Types of

Hotline Complaints

As a result of signing DII, E-Systems established an Ethics Hotline in each

of its divisions so that its employees could report suspected violations. In

June 1987, the Greenville Division received its first hotline call. From that

time until November 1994 (the latest date covered by our investigation),

E-Systems’ hotline log showed that it had opened cases for 260 complaints.

The division delineated the allegations into six categories: (1) improper

time charging; (2) improper work, parts, and procedures; (3) conflict of

interest/vendor issues; (4) safety, security, and drugs; (5) personnel; and

(6) other. Of the 260 cases, 106 related to allegations of procurement

violations and 154 to management and employee-relations issues. (See

table 1.)

Page 5 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
B-265783 

Table 1: E-Systems/Greenville

Division’s Hotline Calls Received

Hotline time frame

Alleged

procurement

violations

Management/

employee

relations issues

Total

hotline

calls

June 1987 -

August 1990a 17 22 39

August 1990 -

August 1993

(Memcor Agreement) 83 119 202

August 1993 -

July 1994b 5 11 16

July 1994 -

November 1994c 1 2 3

Total 106 154 260

aPeriod from hotline inception until beginning of Memcor Agreement.

bPeriod between Memcor Agreement and second administrative agreement.

cPeriod from beginning of second administrative agreement through the latest data received.

The 202 hotline cases opened during the period covered by the Memcor

Agreement were reported to the Army’s Procurement Fraud Division.

According to a DCAA audit report as well as representatives of DCAA, the

Defense Plant Representative Office, and the Defense OIG, E-Systems,

counter to its standards of ethics and DII, did not report to the federal

government any of the 39 cases opened prior to the Memcor Agreement.

E-Systems also did not report to the federal government any of the 16

cases it opened during the period between when the Memcor Agreement

had expired and the second administrative agreement took effect.

E-Systems did report the three cases it received from the beginning of the

second administrative agreement through November 1994.

Complaints Not

Altered but Reports

Did Not Fully Disclose

Investigative Findings

in Three Cases

None of the information that we examined indicated that E-Systems had

altered the hotline reports, or reinvestigated the cases, prepared by the

hotline investigator for cases 66, 114S, and 226—the subjects of concern to

the Subcommittee—to avoid disclosing information to the government.

However, E-Systems’ quarterly reports to the Army did not completely or

accurately disclose the hotline investigators’ findings in the three cases.

The findings in one case were not disclosed at all, while in the two

remaining cases, the reported findings did not reflect those developed by

the hotline investigator. E-Systems’ reports showed that no wrongdoing

Page 6 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
B-265783 

had occurred even though the investigator reported that he substantiated

that it had. DLA later concurred with most of his findings.

According to the former chief investigator for E-Systems’ Greenville

Division, he had substantiated almost all of the allegations in the three

cases. They included allegations of document falsification, false

statements, and violations of company policies. Nevertheless, the quarterly

reports that E-Systems sent to the Army did not include such information.

Regarding the completeness of the quarterly reports, E-Systems’ outside

counsel said the company’s practice was to include all of the allegations of

a hotline case in the quarterly report that closed the case. However, only

case 114S appeared in a quarterly report (Mar. 1992) to the Army when it

was closed. According to an E-Systems representative, the company

inadvertently omitted case 66 (closed in Jan. 1992); and case 226 was not

reported because it was closed in December 1993, after the Memcor

Agreement had expired and before the second administrative agreement

had been implemented. E-Systems did provide the Army a copy of the

quarterly report that contained closing information about case 226, after

the Army requested that it do so as a result of the DLA compliance review

of E-Systems. However, that quarterly report did not contain all of the

allegations received. Instead, the quarterly report stated, in part, “During

the investigation the caller made five other allegations. Of the five only one

required corrective action. . . .” The report provided details about only the

one allegation for which E-Systems required correction.

In a June 28, 1994, letter to the Army’s Procurement Fraud Division,

E-Systems’ outside counsel stated that case 226 had been reported to DCAA

and the Defense Plant Representative Office during a meeting. We

confirmed that E-Systems had discussed case 226 with government

representatives—1 month after E-Systems had been notified of an

impending DLA compliance review of the Memcor Agreement.

Further, E-Systems’ summary reports on two (66 and 114S) of the three

cases—prepared for the Air Force Office of Special Investigations (AFOSI),

the Defense Criminal Investigative Service, and an Assistant U.S. Attorney

during an investigation of E-Systems—also did not indicate any

wrongdoing. Yet, a 1994 DLA report generally concurred with the hotline

investigator’s findings of wrongdoing and noted that E-Systems should

have fully disclosed these findings to the federal government. With regard

to all three cases, the DLA compliance review of the Memcor Agreement

indicated that E-Systems should have involved the government in the

Page 7 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
B-265783 

hotline investigations and should have disclosed suspected wrongdoing to

the government. (App. I, II, and III discuss the three cases.)

No Debarment but

More Detailed

Reporting Required

In April 1994, following DLA’s compliance review of the Memcor

Agreement, DLA reported that E-Systems had violated that agreement by

(1) restricting the agency’s access to hotline files and other supporting

documents and (2) not submitting accurate reports of fraud and ethical

violations. The report continued that E-Systems’ actions during the review

appeared “to run counter to the spirit and letter of the Memcor Agreement,

DII principles and contractor integrity.” As a result of these findings, on

May 26, 1994, the Army’s Procurement Fraud Division required E-Systems

to show cause, or justify, why it should not be suspended or debarred for

violating the Memcor Agreement.

On the basis of E-Systems’ response and a meeting with company officials,

according to the Chief, Remedies Branch, Army Procurement Fraud

Division, the Army determined that it did not have sufficient evidence to

prove that E-Systems had intentionally withheld information from the

government. Nevertheless, to ensure that E-Systems provided the Army

sufficient information to assess the company’s hotline/ethics program, the

Army negotiated a 2-year administrative agreement with E-Systems in

July 1994.

Under the 1994 agreement, E-Systems was required to provide greater

details in its quarterly reports to the Army. According to the Chief, as of

November 1995 E-Systems had provided the information required under

the second agreement. Our review of the first quarterly report submitted

under the second agreement confirmed that E-Systems had provided the

agreed-upon information—nature of hotline allegations, status of

investigations, and their resolution.

Potential Loss to the

Government

The government experienced a potential loss as a result of E-Systems’

actions pertaining to hotline case 226. According to DCAA and AFOSI,

E-Systems employees mischarged their time on case 226 to overhead

instead of to bid-and-proposal costs.4

 E-Systems performed an internal

audit of the charging and, according to an E-Systems official, credited

approximately $33,000 to the government. However, according to DCAA and

AFOSI, E-Systems’ mischarging also affected labor rates charged to

4

Costs allocable to only one government contract are direct costs of that contract and are to be

charged directly to the contract. FAR 31.202(a). Direct costs of a specific contract requirement or an

element of a specific contract’s performance cannot properly be allocated as indirect costs.

Page 8 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
B-265783 

subsequent government contracts and may have resulted in “harm” to the

federal government of about $228,000. As a result, AFOSI and DLA referred

the issue to the Defense Plant Representative Office at E-Systems’

Greenville Division for audit. As of April 1996, according to a DLA official,

the resolution of this issue was still in process.

Further, in case 66 we determined, on the basis of information provided to

us by DCAA, that E-Systems had scrapped purchased parts5

 having a

replacement value of about $92,000. The government later repurchased,

through contracts with E-Systems, many of the same type of parts at a cost

of over $57,000. We were unable to determine what loss to the

government, if any, this constituted because necessary documentation was

unavailable.

We conducted our investigation between June 1994 and December 1995.

Our scope and methodology are discussed in appendix IV.

As arranged with your office, unless you announce its contents earlier, we

plan no further distribution of this report until 7 days after the date of this

letter. At that time, we will send copies of the report to interested

congressional committees; the Inspector General, Department of Defense;

the Chief, Procurement Fraud Division, U.S. Army; President, Raytheon

(which recently acquired E-Systems); President, E-Systems; and the Chief

Executive Officer, Greenville Division, E-Systems. We will also make

copies available to others upon request. If you have questions regarding

this report, please contact me or Assistant Director William L. Davis III at

(202) 512-6722.

Sincerely yours,

Donald J. Wheeler

Acting Director

5

According to DCAA representatives, purchased parts are parts that E-Systems has purchased from

other contractors and then resold to the government.

Page 9 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Contents

Letter 1

Appendix I 

Hotline Case 66 at

E-Systems’ Greenville

Division

12

Allegations 12

Hotline Investigator’s Findings 12

E-Systems’ Reports of Investigative Findings 12

Defense Logistics Agency’s 1994 Compliance Review 13

Appendix II 

Hotline Case 114S at

E-Systems’ Greenville

Division

14

Allegations 14

Hotline Investigator’s Findings 14

E-Systems’ Reports of Investigative Findings 15

Air Force Office of Special Investigations Summary 16

Defense Logistics Agency’s 1994 Compliance Review 16

Appendix III 

Hotline Case 226 at

E-Systems’ Greenville

Division

18

Allegations 18

Hotline Investigator’s Findings 18

E-Systems’ Reports of Investigative Findings 20

Defense Logistics Agency’s 1994 Compliance Review Summary 22

Air Force Office of Special Investigations 23

Appendix IV 

Methodology

24

Appendix V 

Major Contributors to

This Report

26

Table Table 1: E-Systems/Greenville Division’s Hotline Calls Received 6

Abbreviations

AFOSI Air Force Office of Special Investigations

DCAA Defense Contract Audit Agency

DII Defense Industry Initiative on Business Ethics and Conduct

DLA Defense Logistics Agency

GAO General Accounting Office

OIG Office of Inspector General

OSI Office of Special Investigations

Page 10 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Page 11 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix I 

Hotline Case 66 at E-Systems’ Greenville

Division

Allegations On February 7, 1991, a hotline caller alleged that E-Systems had built more

printed circuit boards and panels than required by “planning tickets.”6

Further, the caller alleged that a supervisor had stored excess computer

parts in his office and substituted them on subsequent planning tickets

instead of building new parts as required by the planning tickets.

Hotline Investigator’s

Findings

The hotline investigation substantiated the allegations. Hotline

investigators found excess printed circuit boards and other parts in the

supervisor’s possession after he told them that he had none. The

supervisor later admitted to (1) substituting excess parts, instead of

building new ones, to fulfill subsequent planning tickets and (2) falsifying

the planning tickets to indicate that he had made new parts.

The investigators’ subsequent company-wide examination located more

than 130,000 excess parts. The excess represented parts generally found in

all E-Systems production areas and included such items as electrical

components and sheet-metal parts. The investigation report indicated that,

counter to company policies and procedures, the use of excess parts from

one contract on another contract was a historical practice at E-Systems.

The case was closed January 29, 1992.

E-Systems’ Reports of

Investigative Findings

E-Systems’ Quarterly

Report to the Army

E-Systems reported the hotline allegations to the Army’s Procurement

Fraud Division in a March 29, 1991, quarterly report. E-Systems did not

report the results of the hotline investigation, dated December 2, 1991, in

any quarterly report. An E-Systems representative told us the company

had “inadvertently omitted” the information.

E-Systems, Inc., Greenville

Division Ethics Committee

Review Summary

In a January 1992 report to the Corporate Ethics Program Director,

Greenville’s Ethics Program Director concluded that E-Systems’ policy

regarding excess parts was “not clear or just not followed” and the

supervisor had made no deliberate attempt to hide or manipulate contract

6

According to a DCAA Technical Specialist, at E-Systems all manufactured parts required planning

tickets, i.e., written plans and specifications that accompany the items during their journey from raw

material to finished products.

Page 12 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix I 

Hotline Case 66 at E-Systems’ Greenville

Division

costs. The report further concluded that the supervisor had believed the

process he used was beneficial and followed historical practices.

Greenville Division’s

Summary Report

One stated purpose of the October 1993 Greenville Division report was to

summarize the circumstances associated with the hotline case. However,

the report did not address two related critical issues—the supervisor’s

initial attempt to mislead investigators about his possession of excess

parts and his falsification of documents concerning the parts.

Defense Logistics

Agency’s 1994

Compliance Review

In 1994, DLA completed, at the Army’s request, a review of E-Systems’

compliance with the Memcor Agreement at the Greenville Division. DLA

found that, with the exception of the investigator’s report, the Greenville

Division reports had minimized the importance of the investigative

findings—mischarging, damage to the government, and the supervisor’s

role—by explaining (1) company processes; (2) the causes of the excess

(engineering changes, human error within the production process, and

machinery set-up materials); and (3) the disposition of the parts.

DLA concluded that due to the extensive nature of the improper practices,

E-Systems should have (1) requested DCAA and the Defense Plant

Representative Office to participate in E-Systems’ review of the allegations

and (2) made full disclosure of the investigation findings to the

government. In addition, DLA reported that the supervisor identified should

have been disciplined.

Page 13 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix II 

Hotline Case 114S at E-Systems’ Greenville

Division

Allegations On January 2, 1991, a hotline caller alleged that E-Systems’ quality control

and Material Review Board personnel had rejected—and the customer, the

U.S. Air Force, had agreed to scrap—two printed circuit boards. After the

boards had been designated as scrap, personnel in E-Systems’ Engineering

Department obtained the boards and used them in the Air Force’s final

product. E-Systems falsified paper and computer records to remove the

Material Review Board disposition on the boards from “scrapped” to “use

as is.”

Hotline Investigator’s

Findings

The hotline investigation substantiated all the allegations. The

investigation found that E-Systems’ quality control had rejected the two

circuit boards. The boards were then processed through a Material Review

Board representative, who declared the boards as “scrap” with the Air

Force’s approval and generated new planning tickets to build new boards.

The engineering staff believed the scrapped boards would be functional if

fixed and requested that the boards be turned over to them for use as test

models. Prior to returning the boards to the engineering staff, the Material

Review Board representative broke off one corner of each board to show

that they could not be used in a final product.

About 2 months after the engineering personnel received the scrapped

boards, they canceled the newly generated planning tickets for

replacement boards. They then had the broken corners of the boards

repaired. Subsequently, a Material Review Board representative, who

normally performed quality control in sheet-metal areas and not

electronics, was requested to change the original computer records for the

boards from “scrap” to “use as is.” He did so. In addition, E-Systems

charged all costs associated with reusing the boards as an indirect cost to

overhead instead of directly to the contract. The company subsequently

used the boards in the final product without the Air Force’s knowledge

that they had originally been scrapped and had not been appropriately

tested.

The investigator’s report stated,

“Interviews of the personnel . . . reflects [sic] a total departure and callous disregard for

Company approved and prescribed procedures, overt attempts to hide the fact the boards

were rejected and scrapped, and efforts from the onset to deceive a Quality Control and

MRB [Material Review Board] representative. . . . Investigation shows a clear and deliberate

attempt to by-pass the initial Inspector, Quality Assurance, MRB and Customer

representatives.” (Emphasis added.)

Page 14 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix II 

Hotline Case 114S at E-Systems’ Greenville

Division

The investigator further noted, “New inspectors, MRB and Customer

representatives were sought out, not given all the details, and instructed to

reverse the process.” He continued that E-Systems’ claim of an “urgent

need” for the boards did not exist because the company had had ample

time to manufacture the parts after the initial scrapping.

The case was closed on January 30, 1992.

E-Systems’ Reports of

Investigative Findings

E-Systems’ Quarterly

Reports to the Army

E-Systems reported the hotline allegations to the Army in its March 29,

1991, quarterly report. The caller making the allegations was concerned

that two printed circuit boards that had been rejected and then sent to

Engineering for test work would ultimately be shipped to the Air Force,

which had been informed that the boards were to be used only for test

purposes.

E-Systems reported the results of the hotline investigation to the Army in

its March 25, 1992, quarterly report. The report noted that the investigation

revealed that two printed circuit boards had been scrapped but

subsequently changed to “use as is” to meet an urgent Desert Storm

requirement and that this was done with the concurrence of Engineering,

Quality Control, and the Air Force.

E-Systems, Inc., Greenville

Division Ethics Committee

Review Summary

In a January 30, 1992, review summary, the Ethics Program Director did

not concur with the hotline investigator’s findings, stating “. . . neither that

information nor the interview transcripts conclusively proves [sic] such

conclusions. . . .” The Ethics Program Director also cited the customer’s

approval of the repaired boards’ use in the end product. However, the

director recommended that new procedures, guidance, and changes to the

computerized record system be issued to prevent subsequent changes of

previously entered data.

Page 15 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix II 

Hotline Case 114S at E-Systems’ Greenville

Division

Greenville Division’s

Summary Report With

Concurrence of E-Systems’

Outside Counsel

In May 1993, in response to an AFOSI inquiry, E-Systems’ Greenville

Division issued—and provided to AFOSI, the Defense Criminal Investigative

Service, and an Assistant U.S. Attorney—a report that stated that nothing

in the conduct of division personnel “in any way suggests any element of

deception.” E-Systems’ outside counsel concurred with the report and

justified the employees’ actions by saying their intent was to deliver a

functioning system. Neither the division report nor the counsel’s

concurrence specifically addressed the employees’ actions as contained in

the hotline investigator’s report.

Air Force Office of

Special Investigations

Summary

A February 24, 1994, AFOSI report supported many of the hotline

investigator’s findings and included the following information:

• the estimated value of the printed circuit boards, after electrical

components were added, was about $7,000 each;

• E-Systems, in violation of company policy, used a Material Review Board

member in the Sheet Metal Shop to override the circuit boards’ rejection

by a Quality Control Inspector assigned to the circuit board area;

• the scrapped boards—repaired and manufactured outside of normal

procedures—were used and delivered to the Air Force;

• the repaired boards were never processed through E-Systems’ Quality

Control section and were not manufactured in accordance with military

specifications;

• some costs associated with the production of the boards were charged to

overhead rather than to the contract;

• E-Systems did not perform any functional tests on the boards other than

operationally in the end item;

• the Air Force was given no monetary consideration when the final

products (search receivers) were delivered even though costs were

charged to overhead and then again when the search receivers were

delivered as an end item;

• E-Systems created work orders showing the manufacture of the boards,

after delivering boards to the Air Force; and

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

Defense Logistics

Agency’s 1994

Compliance Review

DLA in its 1994 compliance review report to the Army noted that the hotline

investigation had substantiated the allegations of the improper use of

scrapped circuit boards and the changing of records. DLA concluded that

the hotline investigator’s interviews of company employees had clearly

shown deception by Engineering Department personnel so as not to hold

Page 16 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix II 

Hotline Case 114S at E-Systems’ Greenville

Division

up delivery. The supervisor who had repaired the boards admitted to the

hotline investigator that the boards should have been scrapped.

Furthermore, the Material Review Board representative stated that the

boards should have been destroyed and that he had allowed them to be

used only for test purposes.

In addition, DLA noted that the interview transcripts contained in the

Ethics Program Director’s file showed that a supervisor in the Engineering

Department had made false representations to a government

representative when he said “. . . the only reason those boards were

scrapped was because that corner was notched out.” DLA further

concluded that the outside counsel’s May 1993 position—that nothing

done by E-Systems or government personnel “suggests any element of

deception”—was in direct conflict with the interview transcripts.

DLA also reported that E-Systems should have (1) requested DCAA and the

Defense Plant Representative Office to participate in E-Systems’ review of

the hotline investigation and, (2) due to the apparent intentional

misconduct involved, fully disclosed the investigation findings to the

government. In addition, the report noted that individuals and supervisors

identified by the hotline investigation should have been significantly

disciplined.

Page 17 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix III 

Hotline Case 226 at E-Systems’ Greenville

Division

Allegations On April 19, 1993, a hotline caller made three allegations. During the

subsequent hotline investigation, the caller made five additional

allegations. The following summarizes the allegations raised:

(1-3) The first three allegations in this hotline case involved personnel

matters, not violations of procurement law, and are not addressed in this

report.

(4) Upon termination of an Air Force contract for aircraft equipment,

E-Systems’ Vice President, Finance, caused funds owed to the government

for work completed by the company to be lowered from $1,348,000 to

$1,068,000 without justification.

(5) The Vice President, Finance, violated E-Systems’ ethics policy by not

allowing a voluntary refund to the government for training that E-Systems

had not conducted under a government contract.

(6) The Vice President, Finance, directed employees to mischarge their

time to overhead instead of to bid-and-proposal costs.7

(7) A subcontractor submitted inaccurate time charges to E-Systems,

which were subsequently submitted to the government.

(8) The Vice President, Finance, directed that hazardous duty pay be

added to a government contract after negotiations had been completed

and while the contract was awaiting signature. The direction was refused,

and another vice president signed the contract without the addition while

the vice president who had given the direction was on vacation.

Hotline Investigator’s

Findings

Allegation 4 was not substantiated.

Allegation 5 was not substantiated. However, the Division Counsel sent the

Vice President, Finance, a memorandum along with a copy of E-Systems’

voluntary refund policy for the vice president’s consideration.8

7

Knowingly charging the overhead account for an employee’s time used to prepare bid-and-proposal

information on a specific government contract is a false claim, a violation of 18 U.S.C. § 287.

8

E-Systems’ ethics policy concerning voluntary refunds states, “. . . When it is determined that . . .

overpricing has occurred, then it is the Company’s policy to refund the amount of the overpricing even

when there is no contractual or legal obligation to do so.”

Page 18 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix III 

Hotline Case 226 at E-Systems’ Greenville

Division

Allegation 6 was substantiated. The hotline investigator determined that

company procedures required employees to charge their time to

bid-and-proposal costs (and not overhead) when they were doing technical

writing for a contract proposal. The Division Controller—under the

impression that the Vice President, Finance, had told employees to charge

to overhead—advised several employees that because they were writing

the technical proposal, they should instead charge their time to bid and

proposal. According to the investigator’s report, these employees stated

that the proposal manager, at the direction of the Vice President, Finance,

had told them to charge overhead because the bid-and-proposal budget

had been overrun.

According to the Division Controller, permission had to be obtained from

corporate headquarters if the bid-and-proposal budget was to be

exceeded. The excess still would be charged to overhead, but it became an

unallowable cost and would be taken from the division’s profit.9

 Division

Counsel, after being made aware of the matter by the Division Controller,

wrote the Vice President, Finance, suggesting that he examine the

bid-and-proposal issue. The counsel told the hotline investigator that the

vice president had told the counsel, in effect, “to mind his own business.”

Allegation 7 was substantiated. A Corporate Internal Audit review of the

subcontractor’s inaccurate time charges found that the problem had been

corrected.

Allegation 8 was substantiated in that the directed insertion of hazardous

duty pay was refused and another vice president signed the contract.

However, the Vice President, Finance, told the hotline investigator that the

insertion was not improper because the matter was not a contract; it was a

proposal. He advised that if the customer objected to the new rates the

customer could negotiate them out.

The case was closed on December 5, 1993.

9

According to the Chief, Operations Audits, DCAA, E-Systems’ overhead costs are shared by all

government customers instead of being billed to just the one for which the work is done. He said that

although the bid-and-proposal account is a type of overhead account, employees may charge up only

to a specified limit before the company begins incurring the costs. He said when the division exceeds

the limit, charges then become “unallowable.” In case 226, the Greenville Division’s bid-and-proposal

budget was exceeded.

Page 19 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix III 

Hotline Case 226 at E-Systems’ Greenville

Division

E-Systems’ Reports of

Investigative Findings

E-Systems Corporate

Counsel’s Summary Report

E-Systems’ Corporate Counsel determined that some of the various

allegations involved in case 226 involved financial and legal issues that

should be investigated by someone from outside the Greenville Division.

As a result, it initiated a parallel investigation of the financial and legal

issues to determine if wrongdoing had occurred and what corrective

action should be implemented. The Corporate Counsel invited the hotline

investigator to attend all interviews relevant to the allegations he was

investigating. On August 13, 1993, the Corporate Counsel issued a report

covering hotline allegations 4, 5, 6, and 7. According to the Corporate

Counsel representative who conducted the investigation, these were the

only allegations he examined.

The Corporate Counsel’s report differed from the hotline investigator’s

report. For example, the Corporate Counsel’s report never mentioned that

the investigator reported that at least two employees had directed the

mischarging, one being the vice president whom the Division Controller

and the Division Counsel had told that the charging was incorrect. Instead,

the counsel said, “[S]ome employees may have charged into overhead

accounts rather than [the] bid and proposal (B&P) account.” He said that

the employees working on the program charged to bid and proposal when

writing a substantial portion of the proposal although the majority of the

proposal was written after hours and in small discreet increments.

E-Systems, Inc., Greenville

Division Ethics Committee

Review Summary

A December 15, 1993, Ethics Committee Review Summary found that the

hotline investigation “. . . did not reveal wrongful intent as implied by the

caller’s statements to the investigator. The implication of wrongful intent

was apparently motivated by the caller’s high degree of animosity toward

the Division Vice President.” Regarding the specific allegations, the report

stated the following:

Allegation 4—The investigation did not substantiate the allegation that the

vice president had caused a federal repayment to be lowered without

justification. The report therefore recommended no action.

Page 20 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix III 

Hotline Case 226 at E-Systems’ Greenville

Division

Allegation 5—The investigation did not substantiate the allegation that the

vice president had violated ethics policy on voluntary refunds. Since the

government had accepted the work product, no action was recommended.

Allegation 6—The report did not state that the allegation was

substantiated. However, as corrective actions, (1) the Division Controller

was to issue detailed guidance to employees for labor charging; (2) the

labor charges to identify the financial entries that should be corrected

were audited; (3) DCAA was advised about the “inadvertent” charging errors

and proposed corrections of $33,350; (4) the Vice President, Finance,

position was separated from responsibilities for the Federal Information

Systems proposals and program; (5) the vice president addressed in the

case became the Federal Information Systems Vice President and a newly

selected vice president assumed the finance position; (6) the former Vice

President, Finance, was required to review division policies and explain

them to his subordinates; and (7) the Greenville Division was directed to

conduct a comprehensive director-level training program on

bid-and-proposal labor charging.

Allegation 7—The report did not state that the allegation had been

substantiated. Instead, the report noted that the hotline investigation had

revealed a problem in the calculation of subcontractor’s hours but that the

problem had been detected and corrected before the hotline investigation

had begun. The report had no recommendations.

Allegation 8—The report stated that the hotline investigation had revealed

that a proposal, not a contract, existed at the time the hazardous pay issue

arose. Furthermore, if the hazardous duty rates had been put into the

proposal, the customer would have had an opportunity to negotiate them

out of the contract. The report had no recommendations.

E-Systems’ Quarterly

Report to the Army

E-Systems did not report the five additional allegations in the quarterly

reports covering the period when the allegations were received. The

report—representing November 1, 1993, to March 31, 1994—that

summarized the case after its closure did state that five additional

allegations had been received. However, E-Systems did not send this

report to the Army because, according to a senior legal assistant, the

Memcor Agreement had expired. The report identified one allegation as

needing “corrective action.” It described that allegation as improper

charging of bid-and-proposal costs and noted that erroneous instructions

Page 21 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix III 

Hotline Case 226 at E-Systems’ Greenville

Division

had been given to employees, resulting in about $30,000 of the employees’

time being improperly charged.

Defense Logistics

Agency’s 1994

Compliance Review

Summary

DLA in its 1994 compliance review reached the following conclusions:

Allegation 4—DLA concurred with both the hotline investigator’s and the

Ethics Committee’s reports.

Allegation 5—DLA did not concur with either the hotline investigator’s or

the Ethics Committee’s reports, saying that the matter, though not illegal,

should have resulted in a voluntary refund under company policy. DLA

noted that E-Systems’ policy had been violated and that the hotline

investigation disclosed that training, valued at more than $125,000, had not

been performed even though a government representative signed a form

indicating that it had. DLA reported that the investigation found no

indication of deception on behalf of the company, rather that the

government had mishandled the situation.

Allegation 6—DLA concurred with the hotline investigator’s report that the

allegation was substantiated. However, it did not concur with the

company’s corrective actions regarding the labor charging, including its

lack of disciplinary action against the individuals and supervisors

identified in the mischarging. According to DLA’s report, the hotline

investigator specifically questioned the Vice President, Finance, on his

directions regarding bid-and-proposal costs. DLA reported that, at a

minimum, it was the vice president’s responsibility to ensure proper

charging of costs. DLA concluded that further inquiry into and elaboration

of employee statements may, in fact, demonstrate intentional direction to

employees to mischarge.

Allegation 7—DLA did not concur with the Ethics Committee’s report that

no action be taken. According to DLA’s report, the extent of apparent

subcontractor mischarging—1,000 hours—merited further examination

and formal reporting to the appropriate government authority. Further,

although the company hotline file included a statement to the effect that

the government’s Contracting Officer had been notified, DLA noted that

nothing had been presented in writing.

Allegation 8—DLA concurred with the hotline investigation and the Ethics

Committee’s report saying that the facts in the allegation were correct and

Page 22 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix III 

Hotline Case 226 at E-Systems’ Greenville

Division

that the investigation did not disclose any apparent violation of law,

regulation, or company policy.

Overall, DLA disagreed with E-Systems’ actions regarding hotline case 226.

The report noted that individuals and supervisors identified in the

mischarging allegations should have been significantly disciplined. The

report also stated that E-Systems should have (1) requested DCAA and the

Defense Plant Representative Office to participate in E-Systems’ review of

the hotline investigation and (2) made disclosure to the government due to

the apparent intentional misconduct involved. The report also noted that

the Corporate Counsel’s summary appeared to conflict with the

information obtained during the course of the hotline investigation.

Air Force Office of

Special Investigations

In an October 18, 1995, report, AFOSI confirmed the hotline investigator’s

findings related to the employee mischarges (allegation 6). The report

noted that DCAA estimated that E-Systems’ actions cost the government

about $228,000 because of the manner in which the company had charged

labor rates on contracts negotiated prior to and after the allegations were

raised. The report acknowledged the original $33,000 that E-Systems had

credited to its overhead accounts, saying that DCAA believed the amount

was inadequate.

After the Department of Justice declined to pursue either criminal or civil

action regarding the mischarging, AFOSI and DLA referred the matter to the

Defense Plant Representative Office at E-Systems’ Greenville Division for

“appropriate contractual action.” As of April 18, 1996, according to a DLA

official, resolution of the matter was pending.

Page 23 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix IV 

Methodology

The then Chairman, Subcommittee on Oversight and Investigations, House

Committee on Energy and Commerce, asked us to investigate allegations

presented by the former chief investigator for E-Systems’ Greenville

Division.10 We conducted our investigation from June 1994 to

December 1995.

To obtain the information in this report, we examined Federal Acquisition

Regulations, Defense Federal Acquisition Regulations and related

guidance, Federal Criminal Code and Rules, the DCAA Contract Audit

Manual, the Department of Defense OIG Indicators of Fraud in Defense

Procurement, the President’s Blue Ribbon Commission on Defense

Management Report, the Defense Industry Initiatives, and Department of

Defense documents. We also examined the Memcor Agreement, which

recognized the establishment of E-Systems’ Standards of Business

Conduct and Ethics and the company’s compliance with the Defense

Industry Initiative on Business Ethics and Conduct. We examined written

communications and reports of interviews between the company, DLA,

DCAA, and the Army on the Memcor Agreement’s requirements, the

company’s performance under that agreement, and the 1994 administrative

agreement. We also examined AFOSI reports regarding all three hotline

cases.

We interviewed E-Systems corporate and Greenville Division officials and

staff, including the former chief investigator and Greenville’s Ethics

Program Director for 1989-92. We also interviewed responsible AFOSI,

Army, DLA, DCAA, Defense Plant Representative Office, and Defense OIG

officials and obtained documents pertaining to the oversight of E-Systems’

activities. However, two knowledgeable employees of the Greenville

Division Facilities Protection and Investigations Division—a second

former Ethics Program Director and a hotline investigator—would not

meet with us. In addition, three corporate employees—one of whom had

been an Ethics Program director for the Greenville Division—declined to

answer certain questions pertinent to our investigation.

We reviewed E-Systems’ synopses contained in its hotline log and

quarterly reports of the 260 cases opened between June 1987 and

November 1994. E-Systems’ former chief investigator at the Greenville

Division, who had alleged E-Systems’ mismanagement of hotline

investigations, provided us copies of his investigative reports and records

10According to the former chief investigator, he had previously served 20 years as an investigator and

supervisor for the Army’s Criminal Investigations Division Command and 7 years as an investigator

and supervisor for E-Systems’ Facilities Protection and Investigations Division at E-Systems’

Greenville Division.

Page 24 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix IV 

Methodology

and background relative to investigations that he and his investigative staff

had conducted on three hotline complaints. We reviewed hotline case file

documents obtained from E-Systems’ hotline case files and the Army

Procurement Fraud Division. We focused our review on the three cases

that had been brought to the Subcommittee’s attention and DLA’s

April 1994 report related to them.

Page 25 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
Appendix V 

Major Contributors to This Report

Office of Special

Investigations,

Washington, D.C.

William L. Davis, III, Assistant Director

M. Jane Hunt, Senior Communications Analyst

Barbara Alsip, Communications Analyst

Dallas Regional Office Christina M. Nicoloff, Project Manager

Office of the General

Counsel, Washington,

D.C.

Barbara C. Coles, Senior Attorney

(600359) Page 26 GAO/OSI-96-6 E-Systems’ Reporting of Allegations to the Army
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