Defense Contract Management: DOD's Lack of Adherence to Key Contracting Principles on Iraq Oil Contract Put Government Interests at Risk
Published: 2007-07-31T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Department of Defense's (DOD) U.S. Army Corps of Engineers (Corps) awarded the $2.5 billion Restore Iraqi Oil (RIO I) contract to Kellogg Brown & Root in March 2003 in an effort to reestablish Iraq's oil infrastructure. The contract was also used to ensure adequate fuel supplies inside Iraq. RIO I was a cost-plus-award-fee type contract that provided for payment of the contractor's costs, a fixed fee determined at inception of the contract, and a potential award fee. The Defense Contract Audit Agency (DCAA) reviewed the 10 RIO I task orders and questioned $221 million in contractor costs. We were asked to determine (1) how DOD addressed DCAA's RIO I audit findings and what factors contributed to DOD's decision and (2) the extent to which DOD paid award fees for RIO I and followed the planned process for making that decision. To accomplish this, we reviewed DOD and DCAA documents related to RIO I and interviewed Corps, DCAA, and other officials.
section_title: What GAO Found
paragraphs: DOD considered DCAA's audit findings on the RIO I contract and performed additional analysis before deciding to pay the contractor nearly all of the $221 million in costs that DCAA questioned. DOD did, however, remove about $112 million of the questioned costs from the amount used to establish the contractor's fee pool, which resulted in an effective lowering of the fee received by the contractor by approximately $5.8 million. Lack of timely negotiations contributed significantly to DOD's decision on how to address the questioned costs--all 10 task orders were negotiated more than 180 days after the work commenced. As a result, the contractor had incurred almost all its costs at the time of negotiations, which influenced DOD's decision to pay nearly all of the questioned costs. The negotiation delays were in part caused by changing requirements, funding challenges, and inadequate contractor proposals. In our previous work, we have found that negotiation delays can increase risk to the government. Overall, DCAA considers $26 million of the costs questioned on the RIO I contract to be sustained, which DCAA defines as cost reductions attributable to its audit findings. We compared the sustention rates on DCAA's 11 RIO I contract audits to the sustention rates for 100 DCAA audits of other Iraq contract actions, and found that the sustention rates varied widely for both groups. DOD's Army Corps of Engineers paid $57 million in award fees on the RIO I contract, or 52 percent of the maximum possible, and on individual task orders the fee awarded ranged from 4 to 72 percent of the fee available. While the award fee plan required regular award fee boards during the life of the contract, DOD did not conduct a formal board until nearly all work on the contract was complete. As a result, DOD was not able to provide the contractor with formal award fee feedback while work was ongoing, which federal regulations state should be done in order to motivate a contractor to either improve poor performance or continue good performance. DOD officials told us the workload of RIO staff members and logistical difficulties stemming from the challenging conditions in Iraq hindered efforts to hold evaluation boards during the period of performance. DOD also was unable to give us enough documentation for a full assessment of its compliance with other parts of its plan--it did not, for example, provide the scores the award fee board assigned to the contractor on the individual award fee criteria, so we could not see if the award fee board had followed contract criteria and weighting in evaluating performance. We compared the percentage of award fees earned on the RIO I contract to the fees earned on a group of other selected Iraq reconstruction contracts and found that the percentage of award fees earned on RIO I fell within the lower range of fees earned on the other contracts.

section_title: Letter
paragraphs: The United States, along with its coalition partners and various  international organizations and donors, has embarked on a significant  effort to rebuild Iraq. As of October 2006, the United States had obligated  about $29 billion for reconstruction and stabilization efforts in Iraq. The  United States has relied heavily on private sector contractors to provide  the goods and services needed to support reconstruction efforts in Iraq.  For example, to help reestablish Iraq’s oil infrastructure, in March 2003 the  U.S. Army Corps of Engineers (Corps) awarded the Restore Iraqi Oil (RIO  I) contract to Kellogg Brown & Root. The contract was also used to  import fuels from neighboring countries to avoid domestic fuel shortages  in Iraq. Under this contract, the Corps issued 10 task orders worth  approximately $2.5 billion. The RIO I contract, like many other  reconstruction and support contracts, was a cost-plus-award-fee type  contract. In general, these contracts provide for payment of the  contractor’s allowable, allocable, and reasonable costs; a fixed base fee  amount determined at inception of the contract; and a potential award fee  sufficient to provide motivation for excellence in contract performance. A  cost-plus-award-fee contract, like other cost reimbursement type  contracts, increases the risk to the government of incurring higher than  expected costs, as compared to some other contract types. To mitigate  this risk, these types of contracts require sufficient oversight.
The Defense Contract Audit Agency (DCAA) provides services that can  help the Department of Defense (DOD) ensure accountability for its  acquisitions. DCAA performs audits and provides financial advisory  services in connection with the negotiation, administration, and settlement  of contracts and subcontracts. For example, DCAA has audited many Iraq  contract proposals and contracts and has identified costs it considers to  be questioned. DCAA defines questioned costs as those costs that are not  acceptable for negotiating a fair and reasonable contract price. Ultimately,  the contracting officer has the final decision about whether questioned  costs should be paid, taking into account DCAA’s advice and other  information. On the RIO I contract, DCAA identified $221 million in  questioned costs in its final audits of the task order proposals under the  contract.
Because of your interest in understanding the final agreement reached  between DOD and the contractor on the RIO I contract, we examined (1)  how DOD addressed DCAA’s audit findings on the contract and what  factors contributed to DOD’s decision of how to address these findings  and (2) the extent to which DOD paid award fees for the contract and  followed the planned process for making that decision.
To determine how DOD addressed DCAA’s audit findings on the RIO I  contract and the factors that contributed to DOD’s decision of how to  address those findings, we reviewed negotiation memorandums and DCAA  audit reports for each of the 10 RIO I task orders and other documents  related to the negotiation process and resolution of DCAA’s findings. We  also interviewed Corps, DCAA, and other government officials as well as  contractor representatives. Additionally, to put DOD’s decisions into  context, we compared the resolution of DCAA’s questioned cost findings  on 100 audits of Iraq-related contract actions that were resolved as of the  end of fiscal year 2006 to the resolution of the questioned cost findings on  the RIO I task order audits. Because a contracting officer has the  discretion to determine whether or not to pay questioned costs when  reaching agreement with a contractor, our review does not include a  determination of whether the DOD contracting officer should have  approved payment for the questioned costs.
To determine the extent to which DOD paid award fees for the RIO I  contract and followed its planned process for making that decision, we  collected and reviewed key documents related to the award fee process,  including the award fee determining official’s decision and the award fee  plan. We also interviewed Corps officials to develop an understanding of  the process and outcome for the award fees and contractor  representatives to obtain their perspective on award fees. Additionally, to  put the award fee for the RIO I contract into context, we examined  available award fee documentation for 11 large contracts that DOD  awarded in 2004 to carry out reconstruction activities in Iraq. During the  period we looked at, January 2004 through June 2006, a total of 37 award  fee evaluation periods were conducted for the 11 contracts. Because an  award fee determination is a unilateral decision made solely at the  discretion of the government based upon judgmental evaluations of  individual contractor performance, our review does not include a  determination of whether DOD reached the appropriate award fee  decision for the RIO I contract. Appendix I provides details on our scope  and methodology. We conducted our work from October 2006 through  July 2007 in accordance with generally accepted government auditing  standards.
subsections: section_title: Background
paragraphs: The United States, along with its coalition partners and various  international organizations and donors, has embarked on a significant  effort to rebuild Iraq. As of October 2006, the United States had obligated  about $29 billion for reconstruction and stabilization efforts in Iraq. The  United States has relied heavily on private sector contractors to provide  the goods and services needed to support the reconstruction efforts in  Iraq.
Congress has appropriated substantial amounts to support rebuilding  efforts such as restoring Iraq’s oil and electric infrastructures, assisting in  developing a market-based economy, and improving the country’s health,  education, and medical services. With regard to Iraq’s oil sector, U.S.  support has included efforts to (1) restore Iraq’s oil infrastructure to  sustainable prewar crude oil production and export capacity, and (2)  deliver and distribute refined fuels for domestic consumption. Specific  U.S. activities and projects for the restoration of Iraq’s oil production and  export capacity include repairing the Al-Fathah oil pipeline crossing,  restoring several gas and/or oil separation plants near Kirkuk and Basrah,  and repairing natural gas and liquefied petroleum gas plant facilities in  southern Iraq. U.S. activities also include the restoration of wells, pump  stations, compressor stations, export terminals, and refineries, and  providing electrical power to many of these oil facilities. In addition to  infrastructure restoration activities, from late May 2003 through August  2004, the United States facilitated and oversaw the purchase, delivery, and  distribution of refined fuels throughout Iraq, primarily funded using the  Development Fund for Iraq (DFI). These imports—used for cooking,  heating, personal transportation, and private power generation—were  required to supplement domestic production due to increased demand and  Iraq’s limited refining capacity.
In early 2003, DOD assigned the Corps the responsibility of the oil  restoration activities known as Restore Iraqi Oil. In March 2003 the Corps  awarded a cost-plus-award-fee contract, referred to as the RIO I contract,  to support the oil restoration mission. Under this contract, the Corps  awarded 10 task orders to the contractor worth a total of $2.5 billion. Two  task orders related to oil restoration planning and extinguishing oil fires;  two task orders were for the construction and repair of the oil  infrastructure; one was for life support activities, such as lodging and  dining services; and five task orders were for the importation, delivery,  and distribution of refined fuels throughout Iraq.
At the request of the Corps, DCAA audited the contractor’s proposals for  the RIO I contract. DCAA performs many types of audits for DOD,  including audits of contractor proposals, audits of estimating and  accounting systems, and incurred cost audits. Generally, the results of  DCAA audits of contractor proposals are intended to assist contracting  officials in negotiating reasonable contract prices. Typically, DCAA audits  contractors’ proposals and provides contracting officials advice on the  reasonableness of contractor costs prior to negotiations. DCAA also  conducts audits of cost-type contracts after they are negotiated to ensure  costs incurred on these contracts are acceptable. Relying on cost  information provided by the contractor and assessing whether the costs  comply with government regulations, DCAA may identify certain costs as  questioned. DCAA defines questioned costs as costs considered to be not  acceptable for negotiating a fair and reasonable contract price. DCAA  reports its findings to contracting officers for consideration in negotiating  fair and reasonable contract prices.
DCAA audit reports represent one way DCAA can assist contracting  officials as they negotiate government contracts. Also, contracting officials  may invite DCAA to participate in contract negotiations to explain audit  findings and recommendations. DCAA’s role is advisory, and the  contracting officer is responsible for ensuring that the contractor’s  proposed price is fair and reasonable. While DCAA audit  recommendations are nonbinding, federal regulations specify that when  significant audit recommendations are not adopted, the contracting officer  should provide rationale that supports the negotiation result in the price  negotiation documentation.
In its final 11 audits of the 10 task orders, DCAA identified $221 million in  questioned costs on the RIO I contract. In total, DCAA issued 22 proposal  audits of the RIO I contract because DCAA audited multiple proposals for  some of the task orders. The final 11 audits included one audit of each task  order and an audit of a contractor claim on the life support task order.  Nearly 80 percent of the questioned costs related to the costs paid for fuel  and fuel delivery. For example, DCAA questioned $139 million of the costs  the contractor paid for fuel and fuel transportation in Kuwait based on a  comparison of the price paid by the contractor and the price paid by the  Defense Energy Support Center (DESC) when it took over the mission for  the contractor in April 2004. Figure 1 outlines the reasons for DCAA’s  questioned costs on the RIO I contract.
The RIO I contract provided for payment of a fixed fee of 2 percent of the  negotiated estimated contract cost plus an award fee amount of up to 5  percent, based on the government’s evaluation of the contractor’s  performance. Award fee contracts allow an agency to adjust the amount of  fee paid based on contractor performance. The award fee is intended to  motivate excellence in contractor performance, and can also serve as a  tool to control program risk and cost. However, the monitoring and  evaluation of contractor performance necessary under an award fee  contract requires additional administrative effort and cost, and federal  regulations provide that the use of such a contract is suitable when the  expected benefits of an award fee contract are sufficient to warrant this  additional effort and cost.
In general, for award fee contracts, DOD personnel (usually members of  an award fee evaluation board) conduct periodic evaluations of the  contractor’s performance against specified criteria in an award fee plan  and recommend the amount of fee to be paid. These evaluations are  informed by input provided by government personnel who directly  observe the contractor’s performance. Typically, award fee contracts  emphasize multiple aspects of contractor performance, such as quality,  timeliness, technical ingenuity, and cost-effective management. Because  award fees are intended to motivate contractor performance in areas that  are susceptible to judgmental and qualitative measurement and evaluation,  these criteria and evaluations tend to be subjective. After receiving the  recommendation of the award fee evaluation board, a fee-determining  official makes the final decision on the amount of fee the contractor will  receive. In certain cases the fee-determining official may also decide to  move unearned award fee from one evaluation period to a subsequent  evaluation period or periods, thus providing the contractor an additional  opportunity to earn previously unearned fee—a practice called rollover.
section_title: Delayed Negotiations Shaped DOD’s Decision to Pay the Contractor for Nearly All of the Costs Questioned on the RIO I Contract
paragraphs: DOD considered DCAA’s audit findings and conducted additional analysis  before deciding to pay the RIO I contractor nearly all of the $221 million in  costs that DCAA questioned, and to remove $112 million from the amount  used to establish the contractor’s fixed and award fees. The reduction in  the amount used to establish the fee pool resulted in an effective reduction  of the contractor’s fee by about $5.8 million. DOD’s decision to pay most  questioned costs was shaped by the fact that negotiations did not begin  until most of the work was complete and the costs had already been  incurred. The delay in negotiations was influenced by factors such as  changing requirements, funding challenges, and problems with the  contractor’s business systems. DCAA considers $26 million of the costs  questioned on the RIO I contract to be sustained, which DCAA defines as  cost reductions directly attributable to its questioned cost findings. We  compared the sustention rates on DCAA’s 11 RIO I contract audits to the  sustention rates for 100 DCAA audits of other Iraq contract actions, and  found that the sustention rates varied widely for both groups.
subsections: section_title: DOD Decided to Pay the Contractor for Nearly All of the $221 Million in DCAA Questioned Costs, but Removed $112 Million from the Amount Used to Establish the Contractor’s Fee on the RIO I Contract
paragraphs: To address the $221 million in costs questioned by DCAA, DOD collected  additional information and conducted additional analysis. For example,  after DCAA issued its final audits, DOD collected additional information  related to the difference in costs paid by the contractor and those paid by  DESC for fuel and fuel delivery from Kuwait, as well as price adjustments  the contractor paid to the subcontractor for fuel from Turkey, the two  largest reasons for questioned costs. The DOD contracting officer also  convened a meeting with contractor representatives, DCAA officials, and  other Corps officials to discuss the additional information. As a result of  the additional information and analysis presented in the meeting, the DOD  contracting officer asked DCAA to conduct financial analyses to quantify  options—referred to as financial positions—that he could use in  developing the government’s objectives for negotiations with the  contractor.  The financial positions differed from DCAA’s final audit  reports in some areas, for example, reflecting a narrower gap between the  costs paid by the contractor and the costs paid by DESC for the fuel and  fuel delivery from Kuwait.
DOD decided to address the $221 million in questioned costs in the  following ways:    Pay both the costs and fees. The DOD contracting officer decided to  pay the contractor costs and associated fees for nearly half of the costs  questioned by DCAA. In general, these costs reflected the financial  positions prepared for negotiations by DCAA after DOD collected  additional information about some of the questioned costs. For  example, although DCAA’s final audits questioned the costs paid for  fuel from Turkey, the financial positions did not include reductions for  these costs. The contracting officer used the financial positions as a  basis for deciding to pay the contractor for the costs for fuel from  Turkey.
Not pay the contractor costs or fees. For less than $10 million of  the questioned costs, DOD decided not to pay the contractor for its  costs and the associated fees. For example, the Corps decided not to  reimburse approximately $4 million the contractor spent on leasing  diesel trucks that were not used.
Pay the costs but not the fees. For almost half of the questioned  costs, DOD decided to pay the contractor but removed those costs  from the amount used to calculate the contractor’s fee. These costs  were composed primarily of the difference that remained between the  prices paid by the contractor and by DESC for fuel and fuel delivery  from Kuwait after the contracting officer took into account the  financial positions.
When asked about the reason for paying for questioned costs but removing  those same costs from the amount used to establish the contractor’s fee,  the DOD contracting officer told us that this outcome was a result of  negotiations. He stated that while the contractor probably did not do  everything it could have to lower prices, it took reasonable actions to do  so. For example, Corps officials stated that the contractor attempted to  obtain lower prices for the fuel and fuel delivery from Kuwait through  competition on several occasions. Also, the officials told us that DOD  decided to pay for these questioned costs because it felt that it would have  been unlikely to prevail in an attempt not to pay costs that had already  been incurred by the contractor. Specifically, Corps officials told us they  believed that in the event of litigation, they would have been ordered to  pay the contractor for incurred costs because, for example, the Corps  continually directed the contractor to perform work under the contract.   However, these officials told us they believed there was adequate  justification to negotiate the exclusion of some questioned costs from fee  eligibility.
The DOD contracting officer also believed there were several limitations  to the primary reason for DCAA’s questioned costs—the comparison of the  price paid by the contractor for fuel and fuel delivery from Kuwait to the  price paid by DESC, which took over the fuel importation mission in 2004.  Specifically, the contracting officer attributed the contractor’s higher price  to factors such as the Kuwaiti subcontractor’s perception of the risk of  working in Iraq, short-term subcontracts for the fuel and fuel delivery  because of the incremental funding provided, and differences in overhead  costs. DESC officials also told us there were several factors that limited  the usefulness of the comparison between the prices paid by DESC and  the prices paid by the contractor for fuel and fuel delivery from Kuwait,  such as the fact that DESC could commit to longer contracts with the  Kuwaiti subcontractor and the fact that by contracting with the same  subcontractor, DESC could use the fuel transportation infrastructure  established under the prior contract (i.e., the start-up costs faced by DESC  were lower).
In total, $112 million of the questioned costs were removed from the  amount used to establish the contractor’s fee pool. The contractor’s fixed  and award fees were calculated as a percentage of the costs included in  the fee pool. Consequently, removing $112 million from the amount used  to establish the fee pool resulted in an effective lowering of the fees the  contractor received by about $5.8 million (see table 1 for details).
DCAA officials said they believed the DOD contracting officer followed the  standard process for addressing questioned costs. For example, the  Director of DCAA testified before Congress that the process worked as it  is defined, and that in making its decision of how to address the costs, the  Corps “rightly considered other evidence other than the audit reports and  considered extenuating circumstances that might have affected the  contractor’s actions.” When asked if he was satisfied with the resolution  of the questioned costs, a DCAA official involved in the process told us he  thought the DOD contracting officer did the best job he could, given the  circumstances.
section_title: Delays in Negotiations Influenced the Contracting Officer’s Decision to Pay Questioned Costs
paragraphs: All 10 RIO I task orders were negotiated more than 180 days after the work  commenced, and all were negotiated after the work had been completed.  The RIO I task orders were considered undefinitized contracting actions  because DOD and the contractor had not reached agreement on the terms,  specifications, and price of the task orders before performance began.  Undefinitized contract actions are used when government interests  demand that the contractor be given a binding commitment so that work  can begin immediately, and negotiating a definitive contract is not possible  in time to meet the requirement. DOD requires that contract actions be  definitized within 180 days after issuance of the action or when the  amount of funds obligated under the action is over 50 percent of the not- to-exceed price, whichever occurs first. The head of an agency may waive  these limitations in certain circumstances that likely would have applied  for this contract, including for a contingency operation, but Corps officials  told us that waivers were not requested for these task orders. Figure 2  shows the time it took for DOD and the contractor to reach agreement on  the terms and conditions for the task orders. Because of the delays in  negotiations, virtually all of the costs had been incurred by the contractor  at the time of negotiations.
The contracting officer determined that the questioned costs he decided to  pay were reasonable and in accordance with the FAR, and his decision to  pay nearly all of the questioned costs was influenced by (1) the fact that  nearly all of the costs had been incurred at the time of negotiations and (2)  his belief that payment of incurred costs was required, absent unusual  circumstances.  The contracting officer stated in final negotiation  documentation that unusual circumstances did not exist for most of the  questioned costs.  For example, the DOD contracting officer indicated that  because DCAA chose not to suspend or disallow the funds, which DCAA  can do by issuing a Form 1, unusual circumstances did not exist.
section_title: Changing Requirements, Funding Challenges, and Inadequate Contractor Proposals Contribute to Negotiation Delays and Increase Risk to the Government
paragraphs: Several factors contributed to the delay in negotiations, including DOD’s  changing requirements, DOD’s funding challenges, and inadequacies in  several of the contractor’s business systems. Based on contract  documentation as well as interviews with DOD officials and contractor  representatives, these factors made it difficult for the contractor to submit  proposals in a timely fashion. Without a qualifying contractor proposal, the  government and the contractor are not able to reach agreement on the  terms and conditions of a task order. For many of the task orders, the  contractor did not submit qualifying proposals until late in the period of  performance or after the work had been completed. For example, for 6 of  the 10 task orders, the contractor did not submit a qualifying proposal that  was audited by DCAA until after the period of performance was complete.
Corps officials told us that changing requirements made it difficult for the  contractor to submit a proposal. In particular, the requirements for the  fuel mission were not well defined and changed over time, particularly in  terms of the quantity of fuel needed and the period of performance for the  work. According to Corps officials, the fuel mission was initially  envisioned as a 21-day requirement, but ultimately extended into many  months. The extension of the requirements is reflected in modifications to  task order 5, the initial fuel mission task order, where the period of  performance was extended. Additionally, numerous correspondences  between DOD officials demonstrate the uncertainty as to how much fuel  was required and the time frame during which fuel importation would be  needed. For example, one correspondence indicates that as of April 21,  2003, there was no immediate need for the importation of fuel products  because Iraq was able to provide sufficient refined products to satisfy the  domestic need, and one DOD official considered it unlikely that the need  would arise. Less than 2 weeks later, on May 2, 2003, DOD  correspondence indicates that fuel shortages were anticipated, and DOD  officials began preparations to execute the fuel importation mission. At  that time, officials anticipated the need for 10- to 30-day supplies of fuel,  not a mission that would expand into many months. In addition, the  statements of work for the fuel mission did not outline the quantities  needed to fulfill the mission. The quantities of fuel required changed  numerous times. For example, between July 16, 2003, and August 3, 2003,  the Corps issued four separate letters to the contractor, each one  increasing the quantities of fuel required to fulfill the mission. Overall,  through numerous modifications, the Corps increased the funding on task  order 5 from $24 million to $871 million, a value more than 36 times  greater than the initial allocation.
The Corps also experienced challenges in establishing and maintaining a  consistent, reliable, and sufficient source of funding for the RIO I contract,  which exacerbated the problem of fully defining the requirements. The  RIO I task orders were funded using several sources, including the Army’s  Operation and Maintenance Appropriation, Iraqi vested assets, and the  Development Fund for Iraq. For the fuel mission, a high-level Corps  official involved in the funding aspect of the contract told us that the  Corps had a difficult time finding enough funding to support the mission, a  fact that contributed to short-term requirements. For example, this official  told us that the Corps received funding on a short-term basis rather than  the longer-term funding it requested, which affected the quantity of fuel  the Corps could direct the contractor to purchase. Additionally, to support  the fuel mission when funding was tight, the Corps began using funds from  the infrastructure repair and restoration task orders to fund the fuel  mission task orders, resulting in the delay of work the Corps believed was  critical to the repair of the oil infrastructure.
DOD officials and contractor representatives also told us that the  contractor’s business systems were not fully prepared to handle the  growth in work the company experienced as a result of the war in Iraq,  and this contributed to the delays in proposal submission. From 2002 to  2004, the contractor’s revenues grew from $5.7 billion to $11.9 billion.  Subsequent to the issuance of the RIO I contract, and after the war in Iraq  began, DCAA identified deficiencies in several of the contractor’s business  systems. For example, DCAA considered the contractor’s estimating  system—a system important for proposal development—adequate prior to  the issuance of the RIO I contract. However, subsequent to the issuance of  the RIO I contract, DCAA issued an audit that found the contractor’s  estimating system to be inadequate for providing verifiable, supportable,  and documented cost estimates that are acceptable for negotiating a fair  and reasonable price.
We have shown through our previous work the link between delays in  definitization and challenges with requirements, funding, and proposal  submission. For example, in a review of 77 undefinitized contract actions  issued by various DOD agencies, we found that contracting officers cited  timeliness of a qualifying proposal, changing or complex requirements,  and changes in funding availability as three of the top four reasons for  delays in definitization. In a previous review of Iraq reconstruction  contracts, agency officials told us that delays in reaching agreement on the  terms and conditions of a contract resulted from the growth in  requirements and from concerns over the adequacy of contractor  proposals.
Delays in definitization can increase the risk to the government because  when contracts remain undefinitized, the government bears most of the  risk. For example, in a prior review of how DOD addressed DCAA’s audit  findings on 18 audits of Iraq contract actions, we found that DOD  contracting officials were less likely to remove questioned costs from a  contract proposal if the contractor had incurred these costs before  reaching agreement on the work’s scope and price. In a previous review  of Iraq reconstruction contracts, as well as a review of DOD’s logistics  support contracts, we found that delays in definitizing contract actions can  increase the risk to the government by reducing cost control incentives,  particularly for cost reimbursement type contracts like the RIO I  contract.
section_title: DCAA Attributes $26 Million in Cost Reductions on the RIO I Contract to Its Audit Findings
paragraphs: In total, DCAA considers $26 million of the costs questioned on the RIO I  contract to be sustained. DCAA defines questioned costs sustained as the  negotiated cost reductions directly attributable to questioned cost findings  reported by the DCAA auditor. DCAA’s calculation of questioned costs  sustained includes costs DOD decided not to pay to the contractor and  other types of cost reductions. Specifically, the $26 million of questioned  costs sustained includes (1) $9 million composed primarily of costs DOD  decided not to pay to the contractor and including some costs DOD  decided to pay but moved from one task order to another because of  improper allocation and (2) $17 million in costs removed from the  contractor’s final proposals but questioned by DCAA in prior audits of  previous contractor proposals. For example, in an early version of a  proposal for one of the fuel mission task orders, the contractor proposed  demobilization costs that DCAA questioned. The contractor removed these  costs in a subsequent proposal, and DCAA considered the removal of  these costs attributable to its audit findings, and therefore counted that  amount as sustained. For purposes of calculating a sustention rate, which  is a calculation of questioned costs sustained divided by questioned costs,  in its internal management system DCAA increased its questioned costs on  the final audits from $221 million to $237 million to reflect the $17 million  sustained from prior audits.
Table 2 shows the questioned costs sustained and the sustention rate for  each of the audits of the RIO I contract. The sustention rates ranged from  0 to 20 percent for the fuel mission task orders, which represented a large  portion of the questioned costs. As discussed earlier in the report, the  DOD contracting officer collected additional information and conducted  additional analysis to address some of these questioned costs.  Additionally, he identified limitations to the comparison between the  prices paid by the contractor and DESC used by DCAA to question some  of the fuel costs, such as differences in the length of contract terms for  purchase of fuel and fuel delivery from Kuwait, and referred to these  limitations in his rationale for his decision on these costs.
section_title: The Sustention Rates on the DCAA Audits of the RIO I Contract and the Sustention Rates on DCAA Audits of Other Iraq Contract Actions Both Varied Widely
paragraphs: We compared the sustention rates for the 11 RIO I audit reports to the  sustention rates for 100 DCAA audits of other Iraq contract actions, and  found a similar pattern in the distribution and range of sustention rates for  both groups. Specifically, as shown in figure 3, the sustention rates for  both groups of audit reports varied widely. DCAA officials told us that it is  not unusual to have a sustention rate of 0 percent or of 100 percent on an  individual audit, and these were common values in the two groups we  looked at.
DCAA officials told us that they do not expect every questioned cost to be  sustained, because reasonable people can disagree about how some of  these costs should be resolved. Additionally, as discussed earlier,  contracting officers may consider other information provided subsequent  to DCAA’s issued audit as part of the process of resolving DCAA audit  findings.
section_title: DOD Paid About Half of the Maximum Possible Award Fee for the RIO I Contract, but Did Not Fully Adhere to Key Steps in Its Award Fee Plan for Providing Performance Feedback to the Contractor
paragraphs: DOD paid approximately $57 million in award fees, or 52 percent of the  maximum possible award fee, for the RIO I contract. However, DOD  missed potential opportunities to motivate contractor performance by not  following steps outlined in its award fee plan to provide performance  feedback to the contractor. Further, DOD was unable to provide sufficient  documentation to enable us to fully evaluate its adherence to its award fee  plan. In comparing the RIO I award fee to award fees earned on other  selected Iraq reconstruction contracts, we found that the percentage of  award fee earned on the RIO I contract fell within the lower range of fees  earned on these other contracts.
subsections: section_title: DOD Paid Approximately $57 Million in Award Fees for the RIO I Contract
paragraphs: The overall award fee paid to the contractor on the RIO I contract totaled  about $57 million, just over half of the maximum possible award fee. The  contract provided for a fixed fee of 2 percent of the negotiated estimated  contract cost and an award fee of up to an additional 5 percent that could  be earned based on the government’s evaluation of the contractor’s  performance in areas including technical and cost performance and  business management. The possible 5 percent award fee was based on a  negotiated estimated contract cost of about $2.2 billion, translating into a  maximum award fee of about $109 million. The award fee decision states  that, overall, while the quality of the contractor’s work was generally rated  highly, the contractor did not do as well in the areas of adherence to  schedule and business management. As shown in table 3, the award fee  varied by task order, ranging from 4 percent to 72 percent of the possible  award fee.
section_title: DOD Missed Opportunities to Motivate Contractor Performance by Not Following Key Steps Outlined in Its Award Fee Plan
paragraphs: DOD’s award fee plan for the RIO I contract included several steps related  to providing the contractor with ongoing performance feedback. For  example, the plan called for award fee evaluations to be conducted on a  regular basis during the period of performance. These evaluations were  to include a meeting of the award fee board to determine a recommended  award fee for the contractor and a final decision by the award fee  determining official. After each award fee evaluation, the contractor was  to be notified of the percentage and amount of award fee earned. In  addition to these formal award fee evaluations, the plan also called for  monthly interim evaluations to be conducted in which award fee board  members would consider performance evaluation reports submitted by  DOD staff designated as performance monitors, reach an interim  evaluation decision, and then notify the contractor of the strengths and  weaknesses for the evaluation period.
However, despite its plans to conduct formal award fee evaluations during  the period of performance, DOD did not convene an award fee board for  the RIO I contract until contract performance was almost entirely  completed. DOD officials told us that they were unable to hold boards due  to the heavy workload of RIO staff and logistical challenges such as  difficulties with communications, travel, and security conditions. DOD  officials and contractor representatives also indicated that holding an  award fee board was not a high priority because their focus was on  making sure that the work under the contract was accomplished.  Ultimately only one award fee board was held, in July 2004, after fieldwork  on all but one task order had been completed. The contractor was notified  of its award fee scores in January 2005, after completion of all work on the  contract. This process was in contrast to the rationale for award fee  evaluations explained in federal regulations: Evaluation at stated intervals  during performance, accompanied by partial payment of the fee generally  corresponding to the evaluation periods, can induce the contractor to  improve poor performance or to continue good performance.
In addition to not holding formal evaluations as planned during the period  of performance, DOD did not meet the rigor called for in the award fee  plan when providing interim performance feedback to the contractor.  DOD did provide some interim feedback to the contractor on its  performance during the period of performance. For example, DOD  officials and contractor representatives told us that DOD contracting staff  and contractor staff had daily informal discussions about contractor  performance. In addition, RIO administrative contracting officers sent the  contractor letters on a semiannual basis that provided feedback on the  contractor’s performance. However, as discussed previously, the award  fee plan states that the award fee board should hold monthly interim  evaluations of the contractor’s performance and provide the contractor  with feedback from the evaluations. DOD officials were only able to  provide us with information about one interim evaluation board, and the  contractor was not provided with results from this evaluation. Contracting  staff and others providing feedback to the contractor expressed to us  views ranging from very negative to very positive on the contractor’s  performance during the same time period. Thus, without feedback  reflecting consensus judgment, the contractor may not have been fully  aware of the government’s views on the strengths and weaknesses of its  performance.  Given that the award fee is intended to motivate excellence  in contractor performance, providing the contractor with this type of  feedback is an important step in achieving this aim.
The lack of adherence to the award fee plan also made it difficult to  ensure that all aspects of the contractor’s performance were considered in  the final award fee decision. Although performance monitors were  supposed to complete reports monthly and at the end of each evaluation  period in order to provide the award fee board with information about the  contractor’s performance, which would mean that hundreds of reports  should have been completed during the course of the contract, a DOD  official told us that fewer than 10 performance monitor reports were ever  provided to the award fee board. The board received so few reports  because (1) written reports were not prepared on a regular basis, as  required by the award fee plan, and (2) reports that were prepared were  not submitted to the award fee board. Specifically, DOD officials and  correspondence indicated that performance monitor reports did not begin  to be completed until several months into the contract period of  performance and even then were not completed on a monthly basis. In  addition, DOD officials provided us with more than 25 reports that they  told us had been completed but not provided to the award fee board  members. DOD officials told us that board members were not provided  with these documents because the Corps had received a large number of  documents related to the RIO I contract from Iraq that had not been sorted  through by the time the award fee board was held in July 2004. Because  the DOD officials had not sorted through all of the documents, the award  fee board was also not provided with full information about an interim  evaluation board held in May 2003. Specifically, award fee board members  were provided with only one task order score from the interim evaluation  board, despite the fact that documentation of consensus scores and  contractor strengths and weaknesses was prepared for four task orders.  DOD officials responsible for selecting the award fee board members told  us that they selected board members to ensure that they included  individuals who had directly observed the contractor in different time  periods and locations. However, because the award fee board meeting was  near the end of fieldwork on the contract and because RIO staff rotated  during the period of performance, written observations of contractor  performance would have been important in ensuring that the board had  full knowledge of all aspects of the contractor’s performance.
We have previously reported on problems with DOD adhering to its award  fee process in contingency situations. In our review of DOD’s use of  logistics support contracts, for one large contract we found that the Army  was not holding award fee boards according to the terms of the contract.  We also found that Army officials were not evaluating and documenting  the contractor’s performance on that contract.
section_title: DOD Could Not Provide Sufficient Documentation to Enable Us to Fully Evaluate Its Adherence to Its Award Fee Plan
paragraphs: To evaluate the extent to which DOD followed its planned process for  making the RIO I award fee decision, we attempted to review DOD’s  adherence to the process outlined in its award fee plan, but were not able  to fully do so because DOD could not provide us with documentation of  some elements of the process. For example, according to DOD officials  and the award fee board minutes, the board determined its recommended  score for each task order by first reaching a consensus on individual  criteria outlined in the contract, and then computing the overall score  based on the weighting included in the contract for those criteria.  However, according to DOD officials, they could not provide us with the  consensus scores on the individual criteria because records of those  scores were destroyed after the final award fee decision was reached.  Without these scores, we could not determine whether the award fee  board adhered to the weighting of the criteria outlined in the contract in  reaching its recommendation. We also had limited insight into any  additional factors the award fee determining official considered in making  his initial decision, which included upward adjustments to the award fee  board’s recommendation, because DOD officials could not provide us with  documentation of the reasons for the difference and told us they did not  believe such documentation had ever been developed. This apparent lack  of documentation was not in accordance with the award fee plan, which  states that reasons for any differences between the award fee determining  official’s decision and the award fee board’s recommendation must be  fully documented.
DOD officials also could not provide us with complete information  regarding the monitoring of the contractor’s performance during the  period of performance. For example, we could not obtain full  documentation of interim boards referred to in the award fee board  minutes, including documentation of the number of boards held, the dates  of the boards, or the results from the boards. Without such information,  we could not determine how results from interim evaluations were figured  into the award fee board’s recommendation, as the award fee plan  indicates they should be.
section_title: The Percentage of Award Fee Earned on the RIO I Contract Fell within the Range of Award Fees Earned on a Sample of Other Iraq Reconstruction Contracts
paragraphs: To put the RIO I award fee into context, we also analyzed the award fees  earned on other selected Iraq reconstruction contracts and found that the  percentage of award fee earned on the RIO I contract was within the range  of award fees earned on these other contracts. More specifically, we  reviewed 11 contracts that DOD awarded in 2004 to conduct  reconstruction activities in Iraq, which, like the RIO I contract, were large- scale cost-plus-award-fee contracts. During the period we looked at,  January 2004 through June 2006, a total of 37 award fee evaluation periods  were conducted for the 11 contracts. As illustrated in figure 4, the  percentage of award fee earned during the period varied by contract,  ranging from 20 percent to nearly 100 percent.
section_title: Conclusion
paragraphs: To meet the urgent operational needs of reestablishing Iraq’s oil  infrastructure and importing fuel, the Corps authorized the contractor to  begin work before task orders had been definitized. Factors such as  changing requirements, funding challenges, and problems with contractor  proposals delayed negotiations until well past the timing required by DOD  for definitization. For all 10 RIO I task orders, the work was completed  before negotiations were finalized. Delays in definitizing contract actions  can increase the risk to the government by reducing cost control  incentives, particularly for cost reimbursement type contracts.  In  addition, our findings on the agreement reached between DOD and the  contractor on the RIO I contract build on other significant evidence in our  prior work that the value of DCAA’s audits of contractor proposals is  limited when negotiations take place too long after work has begun.
Award fees can serve as a valuable tool to help control program risk and  encourage excellence in contract performance. To reap the advantages  that cost-plus-award-fee contracts offer, the government must implement  an effective award fee process, which requires additional administrative  effort and cost to monitor and evaluate performance. The FAR requires  that the expected benefits of using a cost-plus-award-fee contract are  sufficient to warrant this additional effort and cost, but in the case of the  RIO I contract, even if this condition had been met, DOD’s Army Corps of  Engineers did not carry out its planned award fee process. According to  DOD officials, efforts to hold award fee boards during the period of  performance were stymied in part by the logistical conditions in Iraq. We  have previously identified problems with DOD’s award fee process in  contingency environments. Given that the award fee is intended to  motivate excellence in contractor performance, providing the contractor  with regular feedback that reflects the consensus of the government about  its strengths and weaknesses is important to enable the contractor to put  forth its best effort to excel in the areas deemed important to the  government. While contingency situations may pose additional challenges  for adhering to an award fee process, without an effective process, the  government risks incurring the additional cost and administrative effort of  an award fee contract without receiving the expected benefits.
section_title: Recommendation for Executive Action
paragraphs: To ensure that cost-plus-award-fee contracts provide the intended  benefits, we recommend that the Secretary of the Army take the following  action:  In contingency situations, as a part of weighing the costs and benefits  of using a cost-plus-award-fee contract, ensure that an analysis of the  administrative feasibility of following a rigorous award fee process is  conducted before the contract is awarded.
section_title: Agency Comments and Our Evaluation
paragraphs: We provided a draft of this report to DOD for comment.  In written  comments, DOD concurred with our recommendation.  The department’s  comments are reproduced in appendix II.  In concurring with the  recommendation, DOD noted a number of factors that exist in this  contingency operation that it believed demonstrated the difficulty of  conducting an analysis of the administrative feasibility of using an award  fee contract in future contingency situations.  These factors included  urgent contracting time frames, uncertain requirements, and difficulties in  identifying appropriate oversight personnel.  As specified in federal  regulations, the use of an award fee contract is suitable when the expected  benefits of such a contract are sufficient to warrant the additional effort  and cost required to monitor and evaluate contractor performance.  It is  precisely factors such as those outlined by DOD that we believe are  important for consideration when determining the administrative  feasibility of a cost-plus-award fee contract in a contingency environment.
As agreed with your offices, unless you publicly announce the contents of  this report earlier, we plan no further distribution until 30 days from the  report date.  At that time, we will send copies to the Secretary of Defense  and other interested parties. We will make copies of this report available  on request. In addition, this report will be available at no charge on GAO’s  Web site at http://www.gao.gov.
If you have any questions concerning this report, please contact me at  (202) 512-4841 or by e-mail at huttonj@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on the  last page of this report. Other major contributors to this report were Marie  Ahearn, Penny Berrier Augustine, Greg Campbell, Arthur James Jr., Eric  Lesonsky, Stephen Lord, Anne McDonough-Hughes, Janet McKelvey, and  Kenneth Patton.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: To determine how the Department of Defense (DOD) addressed the  Defense Contract Audit Agency’s (DCAA) audit findings on the Restore  Iraqi Oil (RIO I) contract and the factors that contributed to DOD’s  decision of how to address those findings, we reviewed negotiation  memorandums and 22 DCAA audit reports, including 11 final audit reports,  for the 10 RIO I task orders.  Additionally, we reviewed other documents  related to the negotiation process and resolution of DCAA’s findings. We  also interviewed Corps, DCAA, and other government officials as well as  contractor representatives. Because a contracting officer has the  discretion to determine whether or not to pay questioned costs when  reaching agreement with a contractor, our review does not include a  determination of whether the DOD contracting officer should have  approved payment for the questioned costs. Additionally, to put DOD’s  decisions of how to address DCAA’s RIO I contract audit findings into  context, we compared the resolution of DCAA’s questioned cost findings  on 100 audits of other Iraq-related contract actions to the resolution of the  questioned cost findings on the RIO I task order audits. We selected the  100 audits for comparison because they represented all audits of Iraq- related contract actions other than the RIO I contract for which DCAA had  calculated the questioned costs sustained as of the end of fiscal year 2006,  excluding those calculated automatically. To ensure we used a consistent  unit of measurement, we used the audit report as the unit of analysis for  comparison. To develop an understanding and assess the reliability of the  information included in the database that contained the results for these  100 audits, we held discussions with and obtained documentation from  DCAA officials located at Fort Belvoir and we conducted electronic and  manual testing for obvious inconsistencies and completeness. We  determined the data used in our review to be sufficiently reliable for our  purposes.
To determine the extent to which DOD paid award fees for the RIO I  contract and followed its planned process for making that decision, we  collected and reviewed key documents related to the award fee process,  including the award fee provisions of the RIO I contract, the award fee  determining official’s decision, the award fee plan, and minutes from the  award fee board meeting. We also interviewed Corps officials, including  the award fee determining official and members of the award fee board, to  develop an understanding of the process and outcome for the award fees,  and contractor representatives to obtain their perspective on award fees.  Additionally, to put the award fee for the RIO I contract into context, we  gathered and analyzed award fee documentation provided by the Joint  Contracting Command-Iraq/Afghanistan for 11 contracts that DOD  awarded in 2004 to conduct reconstruction activities in Iraq. We selected  these contracts because, like the RIO I contract, they were large-scale,  cost-plus-award-fee contracts. During the period we looked at, January  2004 through June 2006, a total of 37 award fee evaluation periods were  conducted for the 11 contracts. In 11 of the 37 award fee evaluation  periods we analyzed, the award fee determining official chose to roll over  the unearned award fee from one evaluation period to a subsequent  evaluation period or periods. In these cases we excluded rolled-over fees  from the available fee pool. Because an award fee determination is a  unilateral decision made solely at the discretion of the government based  upon judgmental evaluations of contractor performance, our review does  not include an assessment of whether DOD reached the appropriate award  fee decision for the RIO I contract.
We conducted our work from October 2006 through July 2007 in  accordance with generally accepted government auditing standards.
section_title: Appendix II: Comments from the Department of Defense