Concerns about the procurement of currency paper resulted in Congress including in the 1997 Emergency Supplemental Appropriations Act a requirement that we complete a comprehensive analysis of the “optimum circumstances for government procurement of distinctive currency paper” and report our findings to the House and Senate Committees on Appropriations. In the conference report accompanying the appropriations bill, the Conference Committee expressed concern over the fact that the Bureau of Engraving and Printing (BEP) of the Department of the Treasury has bought virtually all of its paper for the nation’s currency from a single supplier for over 100 years. The Conference Committee directed that we report on any limitations on competition in currency paper procurement and possible alternatives to the way BEP has been buying the paper, the fairness and reasonableness of prices paid for the paper, the potential for disruption of the availability of currency paper from BEP’s reliance on a single supplier, and other matters. In June 1997, the Chairman of the House Government Reform and Oversight Committee asked that we also report our findings to that Committee because of its interest in federal procurement matters, and Senator Lautenberg requested that we report our findings to his office as well. In September 1997, 16 members of Congress informed us of their interest in our analysis and expressed their opinion that a review of the potential benefits and drawbacks of a single-supplier relationship would be appropriate. The overall objective of our review as stated in the 1997 Emergency Supplemental Appropriations Act was to analyze the “optimum circumstances for government procurement of distinctive currency paper.” However, because that objective was broad and numerous congressional parties were interested in this review, we met with the interested Members’ and committees’ offices to determine the specific issues they wanted addressed as well as approaches to address those issues. Although we identified a number of concerns and issues, they are all covered under the following three objectives: • Have BEP’s efforts to encourage competition for procuring currency paper been effective? • Have prices paid for currency paper been fair and reasonable and has the quality of the paper been ensured? Is there potential for disruption to the U.S. currency paper supply from BEP’s reliance on a single supplier? To address these objectives, we reviewed federal procurement statutes and regulations and specific laws related to currency paper. We reviewed various indicators of the competitiveness of the currency paper market, such as the number of paper manufacturers who said they were capable of supplying currency paper to BEP, and the factors that make it difficult for them to provide currency paper. We also reviewed BEP studies of the currency paper market and obtained information from other federal agencies, such as the Secret Service and the Department of Defense (DOD). To address the first two objectives, we reviewed BEP’s currency paper procurement files for paper contracts in effect from 1988 to 1997, analyzed how BEP bought currency paper during this period, and compared certain BEP actions with requirements in the FAR and applicable laws. We surveyed 30 domestic and foreign cotton paper manufacturers on their interests in supplying currency paper and factors that prevented them from competing for BEP currency paper contracts, and we surveyed other G-7 nations on how they procured banknote paper. We interviewed numerous officials of BEP, Treasury, the Secret Service, the Federal Reserve, Crane, and other agencies. We also interviewed several of the domestic and foreign cotton paper manufacturers that were included in our survey. To help us analyze the fairness and reasonableness of prices paid by BEP for currency paper, we analyzed how BEP used audits of the single supplier’s costs and proposals in its negotiations and evaluated whether BEP had an appropriate basis for determining the fairness and reasonableness of prices it paid for currency paper over the last 10 years. We toured paper mills of two cotton paper manufacturers, as well as BEP printing facilities in Washington, D.C., and Ft. Worth, TX, to observe how paper was produced and currency was printed. To address the third objective, we interviewed officials at BEP, the Federal Reserve, and Crane; reviewed BEP’s contingency plan for critical materials; and asked other G-7 nations what type of contingency reserves of banknote paper they maintained. We did our work in accordance with generally accepted government auditing standards from July 1997 to August 1998. We requested comments on a draft of this report from the Chairman, Board of Governors of the Federal Reserve System; the Secretary of the Treasury; and the Chief Executive Officer of Crane. We received written comments from BEP’s Acting Director that incorporated comments from the Treasury Department, written comments from Crane, and oral comments from the Federal Reserve. BEP’s and Crane’s comments are reprinted in appendixes VI and VII, respectively. Our summary of agency and Crane’s comments and GAO’s responses are discussed at the end of chapter 5. BEP and Crane also provided technical comments, which have been incorporated as appropriate in the report. A more detailed discussion of our objectives, scope, and methodology is contained in appendix I. The optimum circumstances for the procurement of distinctive currency paper would include an active, competitive market for such paper where a number of responsible sources would compete for BEP’s requirements. However, this is currently not the case because of the unique market for currency paper and some statutory restrictions. After over 100 years of relying on a single source, Treasury and BEP completed studies in 1983 and 1996 on what it would take to encourage competition for procuring currency paper, and BEP recently took steps to encourage competition in matters under its control. However, several paper manufacturers told us that they would compete for BEP paper contracts if additional changes were made, such as allowing foreign-owned companies to compete to supply currency paper and extending the length of contracts to more than 4 years. These changes would require existing statutory limitations to be amended. There are also other options for obtaining competition that are allowed under procurement laws and have been used by other federal agencies. When the government purchases common commercially available goods and services, obtaining competition is relatively easy. However, when the government purchases goods that serve only the government’s needs, competition is less likely to occur. In currency paper procurements, obtaining competition is challenging, partly because there are few cotton paper manufacturers, currency paper is unique to the governments’ needs, and a large investment in capital equipment is required. Factors that inhibited competition were identified in the 1996 Treasury/BEP currency paper study. These factors include (1) the cost of the initial capital investment to build or retrofit a plant to produce currency paper; (2) the short start-up period required to comply with specified paper deliveries; (3) the risks and uncertainties inherent in entering a limited, government-controlled market; and (4) the restriction on acquiring distinctive currency paper from foreign-owned or controlled companies contained in the Conte Amendment. Potential suppliers told BEP that it would take between $20 million and $150 million to build or retrofit the necessary plant and equipment to provide currency paper to BEP; and that because of the risks inherent in entering a limited, government-controlled market, some form of financial assistance from BEP would be necessary. The 1996 study also cited delivery requirements, usually requiring delivery starting at or shortly after contract award, as a significant inhibitor, given that manufacturers said it takes 1 to 2 years to become operational. The 1996 Treasury/BEP study also found that the absence of a guaranteed minimum production commitment sufficient to cover the cost of constructing and equipping a plant was an inhibitor. Potential suppliers told Treasury/BEP they would require a long-term commitment to manufacture a minimum of 40 percent of BEP’s requirements in order to begin production. According to BEP, Treasury currently has a study under way aimed at projecting the future demand for currency. The study is being done by representatives from Treasury, BEP, the Mint, and the Federal Reserve. The study is expected to be done by November 30, 1998. BEP awarded five separate contracts to Crane for currency paper from 1988 to 1997. Two of these contracts, 95-23 and 97-10, were awarded to Crane on a sole-source basis. The other three contracts, 88-205, 91-18, and 93-14, were also awarded to Crane because BEP did not receive any other offers in response to its solicitations. Additionally, in accordance with the Conte Amendment, BEP was precluded from awarding a currency paper contract to foreign-owned or controlled firms. Although some matters affecting competition in the currency paper market are beyond BEP’s control, BEP’s solicitations for currency paper before 1997 did not attempt to encourage competition by using means within its control. As shown in table 2.1, some of BEP’s solicitations contained a 1 or 2 year production period and required potential suppliers to start providing currency paper shortly after contract award. Although offerors can always request that financial assistance be provided, BEP did not offer to provide potential offerors financial assistance for capital equipment in its solicitations. In 1997, BEP made significant changes to its solicitation for currency paper. Solicitation 97-13, issued in May 1997, provided for up to a 4-year contract with multiple award scenarios that allowed competitors to submit an offer on various-sized lots and it also provided up to 24 months for a start-up period, under certain award scenarios. Because of BEP’s concerns about violating the 4-year limit on contracts for manufacturing currency paper, the solicitation provided that any required start-up period would be deducted from the 4-year production period. In addition, solicitation 97-13 also provided that BEP will consider “innovative acquisition and financing arrangements” proposed by offerors. Although BEP has taken actions to encourage competition in solicitation 97-13, such as providing for a longer contract performance period than in past solicitations and allowing a 24-month start-up time, some paper manufacturers responding to our survey told us there were other matters that prevented them from competing for the currency paper contract. Some manufacturers said they need an even longer guaranteed contract period, or financial assistance provided by the government, to recover the capital investment required to purchase the equipment to produce the paper. Several paper manufacturers also would like to be able to enter into joint ventures with a foreign paper manufacturer to produce currency paper, but they are unable to do so because of the Conte Amendment, as interpreted by Treasury. Twelve of the 20 paper manufacturers responding to our survey of 30 worldwide firms said that they would be interested in supplying currency paper to BEP and are capable now, or would be in the near future, of supplying at least part of BEP’s currency paper needs, but several matters prevent them from competing. Some of these matters are the same as those identified in BEP’s 1996 currency paper study. None of the 12 interested paper manufacturers said that the size of the currency paper market would make it difficult for them to compete. Table 2.2 summarizes the factors inhibiting competition reported by the 12 paper manufacturers that said they would be interested in supplying currency paper to BEP. Nine of the 12 interested manufacturers said the performance period in BEP’s currency paper contracts has been too short to recover the necessary capital investment. One paper manufacturer said that it is not possible to recover start-up costs in less than 5 years. A second domestic paper manufacturer told us the major reason it did not submit a proposal was that the contract period was too short to recover capital investment, and it believed it was unlikely that this situation could be improved. As a result, this paper manufacturer decided that continuing its investment in product development was too risky and decided not to submit a proposal. According to another domestic paper manufacturer, the amount of capital investment necessary to meet BEP’s requirements cannot be recovered through the price of paper sold to BEP over a 2- to 4-year contract. This paper manufacturer told us that if BEP extends the length of the currency paper contract to at least 10 years it would consider submitting an offer. BEP’s currency paper contracts have generally been for 1 to 2 years with three 1-year options, with the exception of the current solicitation 97-13, which has a performance period of up to 4 years. By law, the contract term to purchase U.S. currency paper cannot exceed 4 years. Additionally, U.S. money order paper contracts are for 5 years; and U.S. passport paper contracts are for 3 base years, with two 1-year options. Both passport and money order paper have security features (i.e., watermarks and security thread) similar to those of currency paper. “None of the funds made available by this or any other Act with respect to any fiscal year may be used to make a contract for manufacture of distinctive paper for United States currency and securities pursuant to section 5114 of title 31, U.S.C., with any corporation or other entity owned or controlled by persons not citizens of the United States, or for the manufacture of such distinctive paper outside the United States or its possessions. This subsection shall not apply if the Secretary of the Treasury determines that no domestic manufacturer of distinctive paper for United States currency or securities exists with which to make a contract and if the Secretary of the Treasury publishes in the Federal Register a written finding stating the basis for the determination.” Although the Conte Amendment itself does not specify ownership and control requirements, the accompanying Conference Report states that BEP may not enter into such a contract with an entity if 10 percent or more of the entity is owned or controlled by a group of foreign persons. In 1995, the report of the House Appropriations Committee that accompanied the Treasury, Postal Service, and General Government Appropriations Act for fiscal year 1996 attempted to redefine the intended meaning of the Conte Amendment. The report stated that a domestic corporation or other entity is one “created under the laws of the United States or any one of its states or possessions, and . . . more than 50 percent of is held by United States citizen(s).” Treasury’s Office of General Counsel concluded in a March 1997 legal opinion that the 1995 House Appropriations Committee Report language cannot modify the constraints established in the Conte Amendment and the contemporaneous explanation of the provision in the 1987 conference report. As part of our review, the House Appropriations Subcommittee on Treasury, Postal Service, and General Government asked us to review Treasury’s position that the Conte Amendment precludes BEP from entering into a contract for the manufacture of distinctive currency paper with an entity of which 10 percent or more is owned or controlled by a foreign company. Because the language designating a 10-percent limitation on foreign ownership or control is in the 1987 conference report and is not specified in the statute itself, Treasury’s interpretation is not mandated by the statute. Nevertheless, in the absence of language in the statute defining what constitutes foreign ownership and control, it is reasonable for Treasury to rely on the 1987 conference report as guidance for interpreting and applying the statutory language. Thus, we believe that Treasury’s interpretation of the restriction in the Conte Amendment is within its discretion. Six of the 12 paper manufacturers we surveyed that were interested in supplying currency paper stated that their decisions not to respond to BEP solicitations had been influenced by the Conte Amendment restriction on foreign ownership. Three of the five foreign paper manufacturers saw this as an issue. According to one domestic manufacturer, the need to have 90-percent U.S. ownership limits a foreign entity from participating in a fashion that gives it any kind of financial incentive. One foreign manufacturer commented that as a foreign paper company, it would want a larger participation than the 10 percent currently allowed. Similarly, two domestic paper manufacturers commented to BEP in 1995 that the restriction on foreign ownership limited their capability to gain access to the only source of currency paper manufacturing expertise, particularly for security threads and watermarks, outside of Crane. Of the 12 interested firms responding to our survey, only 3 foreign firms said they can currently produce all 3 types of currency paper. According to BEP, there are four major currency paper manufacturers that are internationally recognized in currency paper manufacturing and security. Only one of the four, Crane, is located in the United States. The other three, Portals Ltd., Papierfabrik Louisenthal, and Arjo-Wiggins, are located overseas. Portals Ltd., located in the United Kingdom, said it has over 300 years of experience in supplying currency paper to the British government and 40 other countries. Papierfabrik Louisenthal, located in Germany, has supplied banknote paper to Germany since 1967. Arjo-Wiggins, located in France, has supplied banknote paper to France since 1789. American companies that we surveyed said that under the 90 percent U.S.-owned or controlled interpretation, they have difficulty attracting the interest of foreign companies in a joint venture in which their expertise in currency production could be shared. Similarly, Portals, a foreign-owned paper manufacturer, told us it built a paper manufacturing facility in Hawkinsville, GA, in 1980 for two market segments: U.S. currency paper and high-security documents. According to Portals officials, they had been visiting BEP for a number of years regarding their interest in providing upgraded security features for U.S. currency paper. Portals officials stated that on the basis of the favorable reception from BEP, Portals built the Hawkinsville mill, which was capable of producing 2,500 tons of paper a year immediately and had the potential to move quickly up to 10,000 tons of paper a year. Ultimately, it was the passage of the Conte Amendment that caused Portals to sell the Hawkinsville mill in 1988, according to Portals officials. Reliance on a single domestic supplier for currency paper is not unique to the United States. In our survey of the other G-7 countries, Germany, France, and Italy said they restrict their purchases of banknote paper to suppliers located in their countries. England and Canada said that they do not restrict their purchases of banknote paper only to suppliers located in their countries. However, England has historically always purchased its paper from Portals; and Canada competes both the manufacture of banknote paper and the printing of the notes. In Japan, the Japanese government is responsible for producing the paper and printing banknotes. Secret Service officials strongly oppose any production of U.S. currency paper outside the United States because the Secret Service does not have authority to exercise security oversight of the personnel or plant facility in a foreign country. The Secret Service further stated that although it may be able to make agreements allowing for such oversight, a foreign country’s law could preclude any investigative action or oversight by United States law enforcement personnel. The Secret Service also pointed out that the logistics of moving a critical material across borders via a variety of transportation modes would pose additional security risks. BEP security officials told us that they share the same concerns. Secret Service officials pointed out that they did not believe that the percentage of foreign ownership would pose a security problem as long as the paper is produced on U.S. soil. Officials from both the Secret Service and BEP’s Office of Security stated that because of their concern about a catastrophe, they would be in favor of having more than one supplier of currency paper, but they would strongly prefer that suppliers be located in the United States. We agree that the Secret Service and BEP security officials have valid concerns about the manufacture of U.S. currency paper outside the United States. However, there are other components used for currency production in the United States that are supplied by foreign companies. For example, BEP prints U.S. currency on Swiss-designed sheet-fed Intaglio printing presses made by De La Rue Giori; and it buys the sheet currency inspection system and interim currency inspection system from Giesecke & Devrient, located in Germany. Currency ink is bought from Sicpa, a Swiss-owned company, which has facilities in the United States. Additionally, the Federal Reserve’s high speed currency processing machines are made in Germany. Six of the 12 interested paper manufacturers we surveyed said that given the short length of a currency paper contract, the high cost to finance capital equipment inhibits their ability to compete. Financing arrangements to assist these manufacturers could involve extraordinary measures, such as the government sharing in the cost of obtaining the capital equipment needed to build a currency plant by providing government-furnished property or by financing contractor acquired property (CAP). According to one domestic manufacturer, a new supplier would incur significant capital expenditures in order to meet BEP’s requirements, and the use of CAP would be essential to mitigate the capital investment needed. According to the 1996 Treasury/BEP study, the estimated capital investment needed to produce currency paper averaged $40 million and ranged from a low of $20 million to a high of $150 million, depending on whether an existing mill could be retrofitted or a new mill needed to be built. Moreover, the Treasury/BEP 1996 currency paper study also suggested that government financing of potential contractors’ equipment might be necessary to secure competition for currency paper. In July 1996, BEP posted a draft of solicitation 97-13 on the Internet stating that BEP would consider the feasibility of providing CAP. However, in May 1997, Treasury’s former Director of Procurement decided to remove CAP from the solicitation because, in his view, in the form that it was being proposed by BEP, CAP would not have increased competition. The Treasury Procurement Director concluded that a 4-year contract, inclusive of start-up time, would not allow enough actual production time to generate sufficient revenues for the contractors to make it worthwhile for them to risk the substantial investment required to compete, even using CAP. Treasury recommended that BEP revise solicitation 97-13 to state that offerors would be free to propose “innovative acquisition and financing arrangements.” One interested paper manufacturer told us that the removal of CAP from the final solicitation and replacement with language that said BEP would consider “innovative acquisition and financing arrangements” left too much uncertainty about the capital investment issue for the manufacturer to proceed with a proposal. Two other interested paper manufacturers said they would still be interested in competing for the contract without CAP, if the length of the contract were to be extended to at least 5 years. The start-up period historically allowed by BEP is too short, according to five of the paper manufacturers we surveyed who were interested in competing for BEP currency paper contracts. One domestic paper manufacturer said that a short start-up period permits only the incumbent to submit an offer. This paper manufacturer further stated that the 24-month start-up period allowed by BEP in solicitation 97-13 would result in the forfeiture of 2-1/2 years of manufacturing, thus providing for less than the 4-year production period. The paper manufacturer further believes that the start-up period should be added to the manufacturing contract, i.e., a 2-1/2 year start-up period followed by a 4-year contract; otherwise, no paper company would invest in the specialized plant and equipment that are required to meet the government’s security paper production needs before the contract is awarded. Another domestic supplier said that to prepare a facility for currency paper manufacturing would take 1 to 2 years. As noted previously, current law as interpreted by BEP restricts the total period for currency paper production contracts to 4 years. Prior to 1997, BEP required the supplier of currency paper to provide currency paper immediately or shortly after contract award. The start-up period for all distinctive currency paper in solicitation 97-13 is up to 24 months. The requirements to pay a royalty license to use the data and process for insertion of the security thread, the security requirements for the manufacturing process, and the technology required to incorporate anticounterfeiting features in paper were also cited as factors inhibiting competition by 3 of the 12 paper manufacturers that were interested. One paper manufacturer filed a protest with BEP over the security thread license and other issues relating to the current solicitation. Specifically, the paper manufacturer stated that the solicitation places potential offerors, other than the incumbent, in the position of violating a patent held by Crane if they supply currency paper containing security thread made to the specifications outlined by BEP. According to this manufacturer, potential offerors are effectively precluded from providing distinctive currency paper with security thread and new currency design paper with watermark and security thread. In solicitation 97-13, BEP stated that it would provide the security thread as government-furnished material. However, BEP would have to negotiate with Crane to buy the security thread. BEP’s attempts to develop alternative sources in the 1960s and 1980s were not successful for a variety of reasons, including the following: • One firm was unable to price its product competitively with BEP’s traditional supply source for a portion of the currency paper requirement. • BEP discontinued its use of paper that another firm was developing. • The firm that had been developing paper that was discontinued needed technology from a foreign supplier to help it produce other types of paper that met BEP specifications. In 1996, BEP studied the possibility of developing a second currency paper source. It concluded that two sources would probably be more costly than a single source, but it should continue to explore the marketplace through competitive solicitations to determine if there were viable alternative sources. The costs used in the 1996 study were based on an informal survey of paper producers that asked them how much capital investment would be required to prepare paper for BEP. For production costs, BEP assumed that a second producer would incur the same costs as Crane had. BEP’s analysis showed that a second source, producing about 40 percent of BEP’s needs, would increase costs of producing paper by at least $21 million per year and possibly $37 million per year, depending on the amount of capital equipment the second producer acquired. However, BEP’s analysis did not reflect its subsequent decision to accept a higher profit rate with Crane to compensate for Crane’s investment in capital equipment, such as it did on the two most recent contract actions with Crane. Other agencies have found it advantageous to develop a second source. DOD officials told us that they have used a strategy referred to as dual sourcing to develop a second supplier in a sole-source situation for some weapon systems. For example, according to Air Force officials, dual sourcing was used to develop a second supplier to purchase engines for F-16 fighters. Between 1967 and 1972, with few exceptions, the U.S. Mint has awarded the contracts for clad material to one company. However, the Mint realized the vulnerability of having only one supplier, and it attempted to develop additional sources by awarding developmental contracts to firms that were interested in competing for future clad material contracts. However, the vendors selected were unable to produce the material at an acceptable level of quality, according to Mint officials. Although the Mint did not have much success with developmental contracts, it currently has more than one supplier, according to Mint officials. Since 1993, the Mint has purchased clad material from two vendors that share 50 and 45 percent of the contract, respectively. The other 5 percent of the contract is divided between two developmental contractors. Mint officials told us that they did not have a developmental contract with the Mint’s current second supplier, but the second supplier responded to a competitive solicitation issued in 1993. Mint officials said that having two suppliers is better than one because competition helped prevent prices of clad material from rising as rapidly as they would have if there had not been any competition. Although the long-term relationship between BEP and Crane has historically provided quality currency paper, BEP did not generally demonstrate that it obtained fair and reasonable prices for the contracts, options, and extensions awarded between 1988 and 1997. To the contrary, the evidence available in the contract files showed that BEP sometimes paid what it believed to be too high a price when buying currency paper. BEP’s contracting officers recommended accepting prices that they could not determine were fair and reasonable with respect to five contracting actions because there was no other source for currency paper. BEP would not accept Crane’s proposed prices for half of the 10-year period covered by our review. Instead, BEP agreed to pay Crane’s proposed prices as interim prices. The dispute was eventually settled by an arbitrator. The major disagreement between BEP and Crane involved profits until recently, when BEP increased its negotiated profit objectives. In determining whether Crane’s proposed prices were fair and reasonable, BEP relied primarily on audits of Crane’s proposals. However, BEP has not obtained audits of Crane’s cost estimating system or post-award audits of some contracts until recently, made little use of other cost analysis techniques in the earlier contracts in our sample, and made very little use of price analysis. Further, some of BEP’s procurement practices relating to the quantities of paper ordered and its failure to obtain royalty-free rights to the security thread caused, or may have caused, the government to pay more for currency paper than it should have. According to BEP officials, Crane has been a reliable source for paper. BEP and Crane officials said that a paper delivery to BEP has not been missed in over 100 years. BEP officials also said that the overall quality of the currency paper supplied by Crane has been good. In reviewing the files for currency paper contracts in effect from 1988 to 1997, we found only two references to problems with the paper that Crane supplied to the government during this period. The first problem involved bonding of the security thread to the paper. This problem began in 1991 and was due to a change in the adhesive system that was mandated by an environmental ruling in New Hampshire, where the thread was produced. BEP gave Crane a waiver to the contract until the problem was solved in 1994. According to BEP, the resolution of this problem created a second problem, which involved the inability of Crane to meet BEP’s standards for the folding endurance for the security threads. The folding endurance standard specifies how many times paper can be folded before it tears and is a measure of durability. The problem occurred in 1994, after the thread bonding adhesion was changed, and it was brought to BEP’s attention by Crane. BEP granted Crane a waiver from the folding endurance standards for the contract in effect at the time (95-23) and lowered the standard for the subsequent contract (97-10). Of the five contracts awarded from 1988 to 1997, two were awarded on a sole-source basis to Crane. For the other three contracts, BEP issued competitive solicitations. Crane was the only company to submit an offer. In the absence of competition, BEP had to rely on cost and price analyses to evaluate proposed prices to determine if the prices paid for currency paper were fair and reasonable. Price analysis is to be used to verify that the overall price offered is fair and reasonable in comparison with current or recent prices for the same or similar items. Examples of price analysis include comparing proposed prices with (1) prices obtained for similar items through market research, (2) parametric estimates such as dollars per pound, and (3) previous prices. Under the Truth in Negotiations Act, offerors are required to submit and certify cost or pricing data to support the reasonableness of individual cost elements, under certain circumstances, when adequate price competition does not exist. Separate cost elements and profits are evaluated to determine how well the proposed costs represent what the costs of the contract should actually be, assuming reasonable economy and efficiency. Examples of cost analysis include the comparison of costs proposed for individual cost elements to historical costs and the evaluation of the need for and reasonableness of proposed costs. Contracting officers are to determine whether a proposed price is fair and reasonable on the basis of both a cost analysis to ensure the reasonableness of individual cost elements and a price analysis to ensure that the overall price, including profit, is fair and reasonable. The contracting officer’s determination is a judgment based on the results of the cost and price analyses. For the most part, BEP limited its cost analysis techniques to audits of Crane’s price proposals. The audits were done by the Treasury Inspector General (IG) for contracts awarded before 1992 and by the Defense Contract Audit Agency (DCAA) for contracts awarded after 1992. The audits generally consisted of a review of the proposed costs and a test of the reliability of the underlying data and records supporting the proposed costs, as well as the accounting principles used in developing the proposal. In several of the audits, the auditors qualified their work because of Crane’s cost accounting system. For example, for contract 88-205, option 1, the auditors observed that standard costs used in estimating were not adjusted for actual variances, which made them less reliable as a basis for estimation. BEP generally obtained audits of Crane’s price proposals, but it did not conduct a comprehensive price analysis for the five contracts we reviewed. BEP procurement records showed that it did not analyze the changes in prices from one contract to the next and did not compare proposed contract prices to the prices paid for similar items by other government agencies or countries. It did not always review cost trends, such as product yield rates, material prices, and proposed escalation over time, for the earlier contracts in our sample. More specifically, according to BEP’s procurement records: • Audits of proposed costs were obtained for the first three contracts (88-205, 91-18, and 93-14) included in our review, and this information was used to evaluate Crane’s proposed costs; however, additional cost or price analysis was not done for these contracts. BEP stated that it did not have time to do a cost analysis for contract 91-18. • Audits of proposed costs were also obtained for contract 95-23, and this information was used to evaluate Crane’s proposed costs. BEP said that it performed additional cost and trend analysis. • For contract 97-10, BEP again used audit results and did more thorough cost analysis than it had previously done. BEP also did limited price analysis; for example, it compared proposed prices to prices under its existing contracts. A BEP contracting officer said she attempted to obtain prices paid for currency paper from some other governments by telephoning them, but they said they were not willing to share this information due to its proprietary nature. We recognize that other governments may consider such information to be proprietary or be unwilling to share the information with an agency contracting official over the telephone. However, given the interest of the government in achieving a fair and reasonable price in this unique market, other more official and formal efforts to obtain the information, such as inquiries from the Secretary of the Treasury or the State Department, might be more successful. BEP procurement officials said they did not attempt to compare the prices proposed for currency paper with the amounts the U.S. Postal Service paid for money orders or the Government Printing Office paid for passport paper, because the products were different. Although we agree that the products are not identical, they are similar and they are bought competitively. The passport paper is cotton and pulp based, has security thread, and contains a watermark. Money orders also have security threads and watermarks, but they are made from wood pulp instead of cotton. Nonetheless, although comparisons among these types of products would not in themselves have provided a basis for definite conclusions, they may have provided some insight for assessing cost and price trends over time and in demonstrating the effects of competition on prices. The only other analysis used by BEP was for negotiating contract 97-10, and it included an analysis of the effects of changes in quantities ordered on Crane’s production costs. Similar analyses would have been helpful for the other contracts we reviewed. In accordance with section 9003(b) of the 1997 Emergency Supplemental Appropriations Act, the Secretary of the Treasury was required to certify that the price for contract 97-10 was fair and reasonable and that the terms of the contract were customary, appropriate, and in compliance with procurement regulations. The Secretary delegated this determination to the Director of BEP, who made these certifications on September 3, 1997. The five contracts we reviewed from 1988 to 1997 and their options and extensions resulted in 17 contract actions. The prices for the contracts and options are listed in appendix V. For these 17 actions, BEP determined the price to be fair and reasonable for 4, but it was not able to determine the price to be fair and reasonable for 5. BEP did not reach agreement on price for the remaining eight contract actions. For these eight, BEP used interim prices, which were later finalized and reduced by an arbitrator. For the eight contract actions that were finalized by an arbitrator, BEP and Crane were unable to reach agreement on (1) royalties paid to Crane’s affiliated subcontractor that produced the security thread, (2) allocation of commercial sales commissions to government contracts, (3) allocation of legal and consulting costs, and (4) profit. The arbitrator concluded in January 1995 that there was no common control of the affiliated company producing the thread, the allocation of Crane’s sales commissions to government contracts was not appropriate, and Crane’s allocation of legal and consulting costs was proper. The arbitrator also decided that Crane was entitled to higher profits than BEP had been willing to accept because of Crane’s needs for a fair return on its capital investments made to produce paper with less labor. The arbitrator commented that had the DOD weighted guidelines been used, the government’s and Crane’s positions would have been closer. The DOD guidelines provide a structured approach to develop a contract profit objective, and they emphasize the usefulness of facilities’ capital for buildings and equipment used by the contractor to improve productivity or to provide other benefits, such as improved reliability. The arbitrator decided that the settled price should be $212 million, which was $9.7 million (4.4 percent) lower than the interim payments that BEP had made to Crane. According to the arbitration settlement, billings for the subsequent 5 months of one contract action were also settled. During this period, BEP paid $2.1 million more in interim payments than the settled amount, bringing the total amount returned to BEP to $12.7 million. For 5 of the 17 contract actions, BEP was unable to determine the prices to be fair and reasonable. However, it accepted prices for these five contract actions because, according to the BEP contracting files, (1) there was no other source of paper and (2) the Federal Reserve’s currency requirements could not be met if the contract with Crane were not awarded. The major reason why BEP was not able to determine the prices to be fair and reasonable was that BEP contracting officers questioned the profit proposed by Crane. In general, BEP contracting officers were not willing to accept Crane’s proposed profit levels until after the award of contract 95-23, when BEP modified its profit objective by adopting the DOD weighted guidelines. BEP’s application of these guidelines resulted in BEP’s adoption of a higher profit objective. Crane told us that the use of the DOD guidelines resulted in a fair return on the investment made in capital equipment with a minimum amount of labor costs. BEP’s contract files did not indicate that any analysis was done to demonstrate that on BEP contracts for which the DOD guidelines were used to analyze profits, including contract 97-10, the profits were beneficial to the government in that prices would be reduced, labor costs would be reduced, or the government would otherwise benefit. Although BEP primarily relied on audits of Crane’s proposals to determine if the prices proposed were fair and reasonable, two factors qualified the usefulness of these data. First, in a 1994 post-award audit of a cost proposal, DCAA identified about $3 million in over-pricing attributed to Crane’s accounting system. The auditors observed that Crane’s cost accounting system was based on standard costs that were not periodically adjusted to reflect actual costs. Also, in several audit reports covering the proposals for contracts we reviewed, DCAA reported that it had not been asked to review the contractor’s budgeting/estimating system. A second factor was the lack of post-award audits of the contractor’s costs for contracts 95-23 and 97-10. In post-award audits, DCAA attempts to verify whether the costs proposed were based on accurate, complete, and current data as required by the Truth in Negotiations Act. BEP officials said that they asked for DCAA audits of the contractor’s budgeting/estimating system and post-award audits of contracts 95-23 and 97-10 in May 1998. BEP officials said they did not ask for these audits earlier because the contractor’s staff who would be responsible for working with the DCAA auditors were engaged in preparing cost proposals, and BEP did not want to interfere with these activities. Although unrelated to the issue of whether the government paid fair and reasonable prices for currency paper, which is based on the judgment of the contracting officer on the prices proposed for given quantities of supplies, we also found that certain BEP procurement practices contributed, or could have contributed, to higher than necessary currency paper costs. The practices included ordering inconsistent quantities of paper, understating quantities expected to be ordered, and not obtaining royalty-free data rights for security thread used in U.S. currency. According to a former Crane official we interviewed, BEP did not order consistent amounts of the paper under the contracts. Consequently, Crane was not able to maintain a steady production schedule and had to have more equipment than necessary to produce paper to meet BEP’s inconsistent ordering. This official said there were times when Crane’s paper mill would be operating only a few days a week due to lower-than-usual orders for paper; but at other times, the mill would have to operate at full capacity for weeks in order to fulfill a larger-than-usual BEP order. Similarly, the BEP contracting officer noted in an October 1996 trip report on a visit to Crane that Crane requested BEP to commit to leveling out production orders. The contracting officer reported that Crane had experienced four layoffs that year that were costly and could result in the loss of skilled workers. The five contracts awarded from 1988 to 1997 were either fixed-price requirements contracts or indefinite delivery/indefinite quantity contracts. Under either type of contract, the government provides an estimate of the quantities of paper to be bought, and the contractor proposes a price-per-sheet of paper based on that quantity. Because of the relatively high fixed costs in producing currency paper, primarily due to high equipment costs, a higher volume equates to a lower unit cost as the fixed costs are spread over more units. Because paper contracts are awarded on a price-per-sheet basis, government orders in excess of the estimated quantity would be expected to result in lower per sheet actual costs and increased profit per sheet. For example, under the base period for contract 88-205, the contractor provided a price of $.1254 per sheet, based on an estimated quantity of 360 million sheets. BEP actually bought 435 million sheets under this contract, which we estimate to have contributed about $1.5 million in additional contract profits. Other contracts we reviewed also had differences between the estimated contract quantities and the actual orders. A third issue involves BEP’s failure to obtain royalty-free data rights to the security thread used in currency and the process used to insert the thread. Crane, with its affiliated company, Technical Graphics, Inc., holds patents for the thread and the process used to insert the thread in the currency paper. Although this thread is unique to U.S. currency, a BEP official said that the government does not have the patents or a royalty-free license to use the thread because the government never directly paid for their development. The BEP official said that in the early 1980s, Crane approached BEP with an idea for the thread. BEP encouraged Crane to develop it but did not enter into a research and development contract with Crane to develop the concept. A BEP official observed that a research and development contract would have been the vehicle for the government to obtain an interest in the concept. According to BEP officials, Crane used its own funds to develop the thread and insertion process, so Crane is entitled to the patents. BEP officials also said that the government indirectly paid for much of Crane’s development cost. They said the government cannot obtain the royalty-free data rights unless it contracts to do so. Although there have not been any disruptions in the supply of currency paper for the last 119 years, BEP has not been in a good negotiating position and has been vulnerable because it did not have a second source for currency paper or have a reserve inventory of currency paper. The Conte Amendment allows BEP to contract with a foreign entity if a domestic source is not available, thus providing some relief if the current supplier were to encounter a catastrophic incident and be unable to supply currency paper. However, BEP officials told us that a foreign source would require at least 3 months to prepare, produce, and ship watermark and threaded paper and between 1 and 2 months to deliver currency paper without watermarks. BEP is in the process of establishing a 3-month contingency supply of currency paper, which BEP expects to be completed in 1999. Although the longstanding single supplier has been a reliable source of currency paper, the combination of relying on a single supplier and not having an inventory placed BEP in a weak negotiating position and presented some risks. In BEP’s price negotiation memorandums for contracts 88-205 and 95-23, BEP’s contracting officers stated that despite the fact that they considered Crane’s price to be too high, BEP awarded contracts to Crane at the prices proposed by Crane in order to ensure a continuous supply of currency paper. Furthermore, in a meeting between BEP and Crane to negotiate contract 95-23, the parties could not reach agreement over price. The former Chief Executive Officer of Crane said that “BEP would just have to run out of paper,” according to a memo written by a Treasury official dated June 21, 1995. Although BEP and Crane were eventually able to reach agreement, the former Chief Executive Officer of Crane told us that in June 1995 he told Treasury officials, in effect, that he would not agree to another paper contract and that BEP would have to run out of paper. He said that this statement stemmed from issues surrounding the arbitration settlement. He said that a few months earlier, Crane and BEP signed the agreement to accept the terms of the arbitration settlement; however, BEP was still questioning the prices covered by the agreement. According to the former Crane official, the only leverage Crane had to settle with BEP was to not agree to enter into any new contracts. Under the Conte Amendment, if the Secretary of the Treasury determines that no domestic source of currency paper exists in the United States, the requirement for currency paper to be produced in the United States and the prohibition against the purchase of currency paper from a supplier owned or controlled by a foreign entity would not apply. In order to procure currency paper from a foreign supplier, several actions would need to be taken. First, under the Conte Amendment, a written finding by the Secretary of the Treasury justifying the basis for the determination that no domestic manufacturer of currency paper exists must be published in the Federal Register. According to BEP officials, this could be done within a matter of days. Second, BEP would need to contract with Crane to acquire the security thread so BEP could provide the thread as government furnished property. Finally, it would take the foreign paper manufacturer about 3 months to start providing BEP with the currency paper, according to BEP officials. To its credit, BEP recently decided to replace its “just-in-time” approach to maintaining an inventory with a 3-month contingency supply of currency paper. According to its 1996 strategic contingency plan for critical materials, BEP determined that a 3-month contingency supply of currency paper would be adequate. BEP officials said that they will have the inventory built up by 1999. According to the Federal Reserve, it maintains a 40-day supply of finished currency at each of it reserve banks, which would also provide some additional time to bring on another source of currency paper if this were needed. In our survey of other G-7 nations, we were told that the amount of banknote paper maintained in reserve ranged from 1 month in England and Japan to 2 to 3 months in France and Italy. In Canada, the banknote printers are responsible for procuring their own banknote paper. Germany would not provide information on its inventory. Additionally, like the United States, none of the other G-7 nations maintain a second supplier of banknote paper to protect against possible disruptions in the supply of their banknote paper. BEP appears to be ahead of achieving its goal to have a 3-month reserve for each denomination. According to BEP, as of May 1998, it has a 3-month reserve for each individual denomination with the exception of the $20 denomination, which has been recently redesigned. BEP officials anticipate reaching the 3-month reserve for the newly designed $20 note during calendar year 1999. Obtaining competition in currency paper procurement is challenging, partly because of the uniqueness of the currency paper, which requires a relatively large investment in capital equipment. In addition, special statutory provisions govern the acquisition of currency paper that provide a 4-year limit to contracts for the manufacture of currency paper and that it be manufactured in the United States, and prohibit the purchase of currency paper from foreign-owned or controlled entities. Although most BEP solicitations issued before 1997 were competitive, it was not successful in obtaining competition because no firm other than Crane submitted an offer. BEP efforts in the 1960s and 1980s to establish a second source for currency paper also were not successful, for similar reasons. We recognize that there are some uncertainties to the competitive process, even if the existing problems are solved. For example, 12 paper manufacturers told us that they are capable now, or would be in the near future, of supplying at least part of BEP’s currency paper needs if further changes are made. However, we cannot say with any certainty how many, if any, would submit an offer; whether they would be price-competitive with Crane; or if the quality of paper and reliability of delivery would be maintained. In addition, 5 of the 12 paper manufacturers are foreign-owned and are precluded from receiving a contract award under current law. It is uncertain whether the government can successfully develop a second domestic source for future paper needs, primarily because it is unknown how prices would change. Prices might increase if more than one supplier were used. For example, if the same quantity of paper is obtained from two or more suppliers, each with substantial capital investments, the unit price for paper is likely to be higher from each. Therefore, although having a second supplier could lessen the government’s vulnerability to a disruption in supply, having two suppliers could result in an increased cost to the government. On the other hand, a single supplier has less incentive to be efficient or to keep prices and costs to a minimum than suppliers who have to compete with each other, and DOD has reportedly benefited from having a second source in some instances. In its most recent currency paper solicitation, BEP has taken several actions to encourage competition, including providing up to 24 months for potential suppliers to start production for currency paper with additional security features and providing for longer contract performance periods, within the statutory 4-year limit. However, if these steps are not sufficient to encourage offers from additional suppliers, additional actions to promote competition by Treasury and BEP may be appropriate. Given the current statutory constraints; previous efforts to study this problem, as well as Treasury’s ongoing study of future currency demand, which could affect the economic viability of having more that one currency paper supplier; and uncertainties discussed in our report, we believe it is premature to recommend specific steps at this time. Moreover, additional insight on this issue should be available after Treasury completes its ongoing study on future currency demand and as other information becomes available, such as the currency paper prices BEP obtains under its current solicitation and any changes in legislation affecting currency paper procurement that might occur. BEP has not generally been adequately prepared to be in a position to know what it should be paying for currency paper because, until recently, it has done only limited cost analysis and has not used price analysis. BEP could improve some aspects of its currency paper procurements. The evidence demonstrates that BEP (1) lacked an aggressive effort to encourage Crane to develop an acceptable cost accounting system; (2) did not always arrange for post-award audits and audits of the supplier’s cost estimating system; (3) did not include data and analyses in the procurement record that demonstrated the benefit that BEP was to receive when it approved profits that were to recognize or provide an incentive for capital investment; (4) conducted limited analysis of supplier costs and prices, in the context of the worldwide market for currency paper; (5) failed to accurately estimate the amount of paper it needed to procure and ordered inconsistent amounts of paper; and (6) did not take action to arrange for royalty-free access to security thread. In addition to actions to correct these problems, recent efforts to establish a 3-month inventory of currency paper should provide an additional tool to help BEP better ensure that fair and reasonable prices can be achieved. As noted above, BEP has taken several actions to encourage competition. For example, BEP extended the period for potential suppliers to start production for currency paper with additional security features and provided for longer contract performance periods than it had in the past. However, BEP must acquire currency paper within the existing legal framework. According to BEP, the legal framework requires that offerors’ start-up period be included in the 4-year contract period, thus reducing the manufacturing period and limiting the effect of BEP’s actions. According to BEP, the 4-year statutory limit on contracts was created in 1916 to extend the contracts beyond the 1-year statutory limit then in effect, in order to better ensure a reliable supply of materials. BEP’s options for encouraging competition could be further enhanced if Congress lengthened the 4-year limit for currency paper contracts to give potential offerors a longer time to recover their capital investments. If efforts to obtain competition continue to be unsuccessful, BEP’s capacity to achieve fair and reasonable prices could be enhanced through congressional action. BEP’s strategy options could be further strengthened if Congress provided additional authority by modifying the Conte Amendment’s prohibition on procuring currency paper from foreign-owned or controlled suppliers to permit the Secretary of the Treasury to do so on a temporary basis if it is determined that currency paper is not available from a domestic source at fair and reasonable prices. Such a modification could provide additional leverage for the government in its negotiations with the current supplier, or any future domestic supplier(s), and increase the likelihood that fair and reasonable prices can be achieved. To strengthen BEP’s capacity to ensure fair and reasonable prices, we recommend that the Secretary direct BEP to • ensure that the contractor maintains acceptable cost accounting and estimating systems for future contracts and that they are periodically audited; • arrange for post-award audits of the contractor’s costs; include data and analyses in the currency paper procurement record that demonstrate the benefits the government is to receive when it approves profit levels that are aimed at recognizing or providing an incentive for capital investments; and to the extent possible, make more extensive use of price analysis to determine the fairness and reasonableness of prices, including the collection of data from foreign countries on their currency prices and data on similar supplies purchased by other agencies, such as paper for passports and money orders. To further enhance opportunities for other paper manufacturers to offer to provide currency paper to the government and to obtain offers that represent the best value to the government for the paper, we also recommend that the Secretary ensure that all future currency paper procurements reflect the expected amounts of paper needed and orders against contracts are for consistent amounts. This would allow the supplier(s) to maintain a steady production level and stabilize workforce levels. Finally, we recommend that the Secretary ensure that the government obtains royalty-free data rights to any future security measures incorporated into currency paper. To further assist the Secretary in obtaining competition from domestic sources, Congress may wish to consider lengthening the 4-year limit for currency paper contracts to give potential offerors a longer time to recover their capital investments. If adequate price competition among two or more suppliers can be achieved, concerns over whether the prices paid are fair and reasonable should be reduced. Finally, because BEP’s past efforts to encourage domestic competition for currency paper have been unsuccessful and future efforts are uncertain, and because BEP has not always been able to ensure fair and reasonable prices from the current supplier in some past procurements, additional authority may be necessary to protect the government’s interests in obtaining currency paper. Specifically, Congress may want to consider revising the Conte Amendment, which allows the Secretary of the Treasury to obtain currency paper from a foreign-owned source only if no domestic supplier is available, to permit the Secretary to authorize obtaining currency paper from a foreign-owned source on a temporary basis if it is determined that no domestic supplier will provide paper at fair and reasonable prices. Such a provision should improve the likelihood that fair and reasonable prices could be obtained. We provided copies of a draft of this report for comment to the Chairman of the Board of Governors of the Federal Reserve System, the Acting Director of BEP, the Secretary of the Treasury, and the Chief Executive Officer of Crane. On July 29, 1998, the Assistant to the Board of Governors of the Federal Reserve System provided oral comments on our draft report. He said the Federal Reserve considered the analysis and recommendations to be reasonable. We also received written comments from the Acting Director of BEP, dated July 29, 1998, which are reprinted in appendix VI; and we received written comments from Crane dated July 28, 1998, which are reprinted in appendix VII. According to BEP officials, the BEP comments included input from the Department of the Treasury. Finally, in a meeting with us on July 29, 1998, BEP provided a number of oral technical clarifications to our report that we made where appropriate. The Acting Director of BEP stated that our report does not recognize that BEP complied with the FAR in the award of the five contracts we reviewed and provided comments on our recommendations. We did not make a comprehensive assessment of BEP’s compliance with FAR in connection with the five contracts we reviewed and thus are not in a position to make an overall statement on BEP’s compliance. Our draft report included recommendations that BEP (1) consider amending solicitation 97-13 and future solicitations to provide financial assistance if deemed to be economically advantageous to the government; and (2) consider excluding Crane from some or all of BEP’s currency paper requirements, as an example of a strategy to establish an alternative source. In its comments, BEP endorsed the idea of providing financial assistance but did not agree with amending solicitation 97-13 because it believes solicitation 97-13 provided for financial assistance. In addition, BEP said that Treasury is currently studying the future demand for currency, and once the study is completed, BEP will be in a better position to assess the cost reduction potential associated with developing additional suppliers. BEP also disagreed with our recommendation that Treasury consider excluding Crane from some or all of BEP’s currency paper requirements. BEP said that excluding Crane from competing for all of its requirements was not feasible because of the lack of an alternative domestic source; and excluding Crane from part of its requirements would not be practical or economically feasible, citing a previous determination that the price for currency paper could increase significantly due to the high capital investment cost for a potential new supplier. After carefully considering BEP’s comments as well as reconsidering the uncertainties we identified in our draft report, we agree with BEP that amending solicitation 97-13 to offer financial assistance and excluding Crane from all of its requirements could create difficulties for BEP in meeting its responsibilities to ensure an adequate supply of currency paper. We also agree with BEP that it should be in a better position to evaluate the feasibility of establishing additional suppliers after Treasury completes its ongoing study of future currency demand, which Treasury expects to be done soon. In fact, our draft report recognized that future currency paper demand was one of the factors that needed to be considered in deciding on the feasibility of additional suppliers. Accordingly, we deleted our recommendations to the Secretary aimed at encouraging competition to reflect BEP’s concerns, the uncertainties identified in our report, and because of Treasury’s ongoing effort to project future currency demand. However, we believe that future consideration by Treasury of additional measures to encourage competition may be appropriate after it finishes its study of future currency demand for a number of reasons. First, significant changes in future currency demand could affect the economic feasibility of establishing other suppliers. Second, BEP’s statement that it has determined that establishing another supplier would not be economically advantageous appears to be based on its 1996 currency paper study, which was done before BEP accepted higher prices for newly designed currency paper under contract 97-10; higher prices could affect the conclusions Treasury reached in its 1996 study. Third, Treasury’s report on its 1996 currency paper study did not fully address the economic feasibility of establishing a second supplier under different scenarios that would be possible if existing restrictions on the contract period or percentage of foreign ownership and control were changed. Regarding our recommendation to ensure the contractor maintains acceptable cost accounting and estimating systems, BEP said that it has audited the contractor’s cost accounting practices and will continue to do so. However, on July 29, 1998, BEP officials told us that they still had not obtained an audit of Crane’s estimating system. We believe that this should have been done earlier because the estimating system helps to ensure that cost proposals are based on reliable and consistent data. In reference to our recommendation to arrange for post-award audits for the contractor’s costs, BEP said that it had requested audits and that ongoing IG and DCAA investigations and audits occasionally interfered with timely post-award audits. We believe BEP should continue to pursue these audits because past efforts to follow up on obtaining post-award audits have not always been timely and because they help protect the government’s interests. With respect to our recommendations that solicitations reflect expected paper needs and that orders be evened out, allowing the supplier to maintain a steady production level, BEP agreed that improvements were needed and says it has taken corrective actions to ensure that the quantities bought under contract 97-10 represent actual requirements. We believe these actions are a step in the right direction and should be continued in future orders of currency paper. BEP disagreed with our recommendation that it make more extensive use of cost and price analysis. BEP pointed out that in its two most recent contracts, it had applied a number of cost analysis techniques. Our draft report recognized that BEP had done more cost analysis on contract 97-10 than had been done in previous contracts. However, BEP did not do adequate price analysis for any of the five contracts we reviewed, including 97-10, and did not do adequate analysis to support the profit levels it accepted. Accordingly, we modified our recommendation to address the need for greater analysis of proposed profit levels. Regarding our recommendation to collect pricing data from foreign countries, BEP said it would continue to try to obtain foreign country currency paper data. We added some language to the report to clarify how this might be done. With respect to the related suggestion that BEP collect pricing data on similar supplies purchased by other agencies, such as passport and money order paper, BEP said it believed comparison of currency paper prices to passport and money order paper would not produce any meaningful information. BEP said these papers are different from currency paper. Our report recognizes that although comparisons of these types of papers would not provide a basis for a definitive conclusion, they may provide some insight for assessing pricing trends. BEP said it agreed with our recommendation to obtain royalty-free data rights to future security measures. BEP pointed out that the cost of such royalties for the security thread is less than 0.2 percent of the cost of the currency paper contract. However, BEP did not address the effect these patents had on its 1997 competitive solicitation or could have on future solicitations. As discussed in chapter 2, several paper manufacturers stated that the requirements to pay a royalty license to use the data and process for insertion of the security thread made it difficult for them to compete. One paper manufacturer filed a protest with BEP over the security thread license and said that the solicitation places potential offerors in a position of violating a patent held by Crane if they supply currency paper containing security thread made to BEP’s specifications. In response to this protest, BEP agreed to provide the security thread as government-furnished property. Crane provided very lengthy comments on many of the issues addressed in this report. Our specific responses to the comments are included in appendix VII. In general Crane said that although it agreed with many of our factual findings, it disagreed with most of our recommendations and one of our matters for consideration of Congress. Crane also suggested specific technical changes to clarify our report that we have made where appropriate. In objecting to our recommendations that BEP and Treasury take further steps to encourage competition in the supply of the nation’s currency paper, Crane said that they have already been adopted by BEP and no further action was necessary. Crane specifically objected to the recommendations in the draft report that BEP further consider options for providing financial assistance to other potential suppliers and that BEP consider excluding Crane from all or some of its currency paper requirement to encourage participation by other potential suppliers. While these strategies are permitted under law, Crane said that they would result in higher costs and possible disruptions to the supply of currency paper. As we explain in response to BEP’s concern about these recommendations, we acknowledge and stress in the report that the impact of alternative strategies is uncertain and that many factors would have to be weighed in considering any option. In light of BEP’s concerns and to recognize the uncertainty involved, we have deleted the recommendations proposed in our draft report to encourage Treasury and BEP to further consider the feasibility and advisability of additional measures to encourage competition. Crane agreed with our suggestion to Congress that consideration be given to modifying the 4-year limit on currency paper contracts. However, Crane opposed our further suggestion to Congress that the Secretary of the Treasury be given additional authority to acquire currency paper from foreign-owned firms in the event that fair and reasonable prices cannot be obtained from a domestic source. We can understand Crane’s position on this matter, since it believes that its prices have been fair and reasonable, and that the alternative of acquiring currency paper from a foreign source is not necessary. However as our report clearly states, there have been occasions in the past in which BEP has not been able to determine that Crane’s prices were fair and reasonable, but the lack of other domestic suppliers and the current restriction prohibiting acquiring currency paper from foreign-owned sources unless no domestic source exists has limited the negotiating strategies. For these reasons, we continue to believe that Congress should consider limited expansion of the Secretary’s authority.

Summary: Pursuant to a legislative requirement, GAO provided information on the: (1) optimum circumstances for the procurement of distinctive currency paper; (2) effectiveness of the Bureau of Engraving and Printing's (BEP) efforts to encourage competition in the procurement of currency paper; (3) fairness and reasonableness of prices paid for currency paper by BEP and the quality of the paper purchased; and (4) potential for disruption to the U.S. currency paper supply from BEP's reliance on a single source. GAO noted that: (1) the optimum circumstances for the procurement of distinctive currency paper would include an active, competitive market for such paper, where a number of responsible sources would compete for BEP's requirements; (2) however, these circumstances have not existed because of the unique market for currency paper and some statutory restrictions; (3) BEP has been aware of the need to increase competition and has made some efforts recently to do so in areas under its control; (4) however, BEP must procure currency paper within the current statutory framework, which limits currency paper contracts to 4 years, prohibits currency paper production outside of the United States, and prohibits purchase of currency paper from foreign-owned or controlled entities; (5) of the 20 paper manufacturers that responded to GAO's survey, 12 said they were interested in and have the capability now, or could be made capable in the near future, of supplying at least part of BEP's currency paper needs if existing statutory requirements and some of BEP's solicitation terms were changed; (6) 7 of the 12 are domestic paper manufacturers, and 5 are located in foreign countries; (7) although the long-term relationship between BEP and Crane & Co., Inc. has historically resulted in quality currency paper, BEP was unable to determine that it had obtained fair and reasonable prices for 13 of the 17 contract actions awarded from 1988 to 1997; (8) BEP sometimes accepted prices even though it was unable to determine that they were fair and reasonable because it had no other source for currency paper; (9) GAO believes that BEP's assessments of the fairness and reasonableness of Crane's proposed prices were hampered by a number of factors, including the lack of market prices for currency paper and the limited analyses of proposed costs and prices it performed; (10) as the government's agent for acquiring currency paper, BEP is responsible for ensuring that the government's supply of paper is not disrupted; (11) although the potential for disruption in the supply of currency paper exists, there have been no such disruptions; (12) however, for many years, because BEP did not maintain a reserve inventory of paper to provide for contingencies, it was more vulnerable to adverse consequences if a disruption had occurred and was at a disadvantage in its contract negotiations because it lacked an alternative source for currency paper; and (13) BEP has recently been purchasing paper to build a 3-month reserve supply and, under the Conte Amendment, could buy paper from a foreign source if no domestic source exists.