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Exempt From The Rules: Defense Contractors?


Most vendors with whom the government does business are subject to a very high degree of scrutiny in their dealings, to ensure that the public trust, and the public coffers, are not unduly burdened by overly zealous corporate interests.

Yet, In recent decades, it has become clear that major military contractors have a de facto special status in their dealings with the government. Especially in the case of suppliers of major weapon systems priced above the $1 billion threshold, there seems to be a paradoxical deference to corporate wishes. Increasingly, this deference has become a disturbing trend, as it has been extended to other major contractors, such as those who are engaged in services and reconstruction efforts in Iraq and in the post-Katrina rebuilding efforts.

Defense contractors who seek to be paid for cost overruns, beyond the original contract amount, routinely have their contracts amended to pay them the additional amounts, despite the absence of changes to the contract's quantity or quality specifications. Completion and delivery deadlines, which are missed, may result in a phone call, but seldom lead to reduced payments or penalties. Quality deficiencies not only do not lead to payment reductions; they, appallingly, do not impair the contractor's standing to bid on, or be awarded, future contracts with the Department of Defense (DOD).

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The Federal government acts as if it is beholden to these interests. In effect, as long as a private sector company is providing a major military system or service, our government seems to respond to contract violations by saying: "We need you, so take the money, it's okay, and if you want more, just ask."

There may be a link between this deferential attitude and campaign financing, as defense contractors are major contributors to both Democratic and Republican candidates. But even if that is not the reason, and the explanation is simply that there is a unique national security need for the products proffered by these companies, the result is no less intolerable. In fact, if the rationale really is one of dependency on these contractors, in that we need to maintain viable domestic military suppliers, for national security reasons, so as to be self-sufficient in wartime, then that relationship bestows a quasi-governmental function on them, and an even greater responsibility applies. In such case, a fiduciary duty to act in the best interests of the American people and the Federal budget should attach.

In light of the merger mania among many of the U.S.'s principal defense contractors and suppliers in recent years, especially in the aerospace and projectile industries, the dangers are even further amplified. With fewer major suppliers from which to choose, our government is even more vulnerable to, and more dependent upon, the good graces and responsible behavior of these companies than ever before, as there are fewer alternative companies to which to shift in the event of a problem.

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Ideas / Solutions

To safeguard the public trust, ensure corporate responsibility in dealings with the government, and protect a level playing field between defense contractors and our taxpayers, some reforms should be initiated.

First, the Federal government should establish maximum profit margins that can be achieved through contracts with our military. While this may not be tenable with regard to a company supplying consumer goods such as paper towels to the Army, the major weapon system contractors, by dint of their quasi-public function and high-dollar contracts, are subject to greater accountability. Companies certainly are entitled to reasonable profits, but the DOD should simply have the courage to negotiate, in advance of entering into the contract, to establish an appropriate amount of corporate profit that it is willing to pay.

This is squarely within the rights of a party to any contract, and, should become a routine procedure at the DOD, too. Even if this is part of the official rulebook today, it is neither executed nor enforced regularly, if at all, and certainly not scrupulously enough to avoid problems and the appearance of impropriety. Contract managers at General Motors would probably be fired for the lackluster application of smart buying techniques that are endemic at the DOD.

Second, contract officers should be required to increase scrutiny of the accounting methods utilized by the contractors in formulating their contract bids, and, prior to awarding a contract, question each and every expenditure of significance. After entering into a contract, the DOD should routinely do pre-audits of all requests for payment prior to the release of ANY funds, to ensure that contract performance is on schedule and in line with quality expectations. In so doing, contract officers and auditors would also be able to identify accounting games whereby corporate profits are built into the contract under the disguise of being a category that is not labeled as profit.

Third, goods and services received by the DOD, which are substandard in quality, should automatically result in the withholding of payment. If payment had already been made, then restitution should be demanded in proportion with the percentage of the goods and services that were substandard. Even stronger action should be taken, and penalties should be applied, when the products received are actually defective. It is an obvious principle, yet, a too-often-neglected one. While there should be leniency for minor, correctable deficiencies and inadequacies that are not material to the contract, even in these cases, at least remedial actions and minor sanctions should be imposed.

Fourth, a contractor that materially or significantly violates the terms of the contract should be barred from bidding on any other government contract for a period of at least a few years. The barrier should be extended if the contractor does not provide sufficient assurances that no similar or foreseeable deficiencies will occur in future dealings. Only with genuine, meaningful penalties can there be assurance of conscientious, satisfactory contract performance.

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Fifth, to guard against situations where the DOD is at the mercy of its contractors, efforts must be made to move from exclusive contracts with a sole supplier to joint ventures, or other multi-party contracts which involve more than one supplier. If the entire contract is awarded to only one company, then naturally, if the company chooses to hold the government hostage to its desires or interpretation of the agreement, then the company can maximize their re-negotiation leverage. If the full supply order is divided between at least two major competitors, then, if one of the parties acts unreasonably, the DOD at least has the option of increasing its reliance on the other party for the DOD's needs. Similarly, contract specifications should be crafted in ways to enable other parties to substitute for the original contractor in the event of a contract deficiency.

Finally, when a contractor seeks to increase the amount of money to be paid to them under the contract, the decision whether to augment should be based the government receiving a better product, more of the product, or a more timely product than was originally anticipated. If this test is met, a determination should still be made as to whether such change increases the value of the contract from the perspective of the government. If so, the increase should be narrowly tailored to correspond to the increased value. In no case should a contractor receive a greater amount of money, on the basis of the company's cost overruns, miscalculations, or other highly suspect reasons, for essentially the same performance originally envisioned when the contract was executed.

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The essential point is that it is not the government's function to serve as guarantor of a company's sustainability simply because the company is engaged in a defense-related activity. We must be mindful of President Eisenhower's cautionary farewell speech, when he warned the nation about being beholden to defense contractors, a.k.a., the military-industrial complex. Our government must hold primary its duty to our citizenry to wisely spend our tax dollars, and corporations must rely upon their own professionalism to ensure their own viability.

Even though these initiatives have focused on major defense systems, if they were already institutionalized at the DOD, it would not have been possible for Halliburton to reap windfall profits from its engineering and supply services in Iraq that have been reported. Also, due to its cost overruns on previous contracts, Halliburton (through its subsidiary Kellogg, Brown, and Root) would not have been eligible to receive recent contracts for rebuilding in Iraq, nor its contract, worth up to $385 million, with the Army Corps of Engineers for building temporary immigration detention centers in the US. Similarly, Parsons Corporation would not have been able to receive contract funds for health centers in Iraq which it did not build, nor for others that it built defectively.

Similar reforms and fiscal discipline should be imposed in other Departments to avoid similar problems, such as the payments to cruise lines that serve as temporary homes for people displaced by Hurricane Katrina. It has been estimated that as much as 70% of Katrina rebuilding contract dollars have been awarded through no-bid or limited-bid contracts to firms such as Bechtel, the Shaw Group, CH2M Hill, and Fluor Corp., potentially resulting in as much as $2 Billion in wasteful contract spending. Considering the billions of dollars that are being spent, and will continue to be spent, repairing the damage from Katrina, the continued absence of contract accountability measures would be sure to result in more outlandish improprieties in the years to come.


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