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National Security and International Affairs Division

B-242137 July 8,199l The Honorable John D. Dingell Chairman, Subcommitteeon Oversight and Investigations Committee on Energy and Commerce House of Representatives Dear Mr. Chairman:

This report summarizesour analysis of the Navy’s review of allegations of improper charges and other contractual issuesat Bath Iron Works, Bath, Maine. As requested, we plan no further distribution of this report until 30 days after its issue date, unless you publicly announce its contents earlier. At that time, we will send copies to the Secretaries of Defense and the Navy and appropriate congressionalcommittees. We will make copies available to others upon request.

Pleasecontact me on (202) 276-6604 if you or your staff have any questions concerning this report. Major contributors to this report are listed in appendix I. Sincerely yours,

Martin M Ferber Director, Navy Issues Executive Summary

In October 1989,GAO received allegations from an anonymoussource Purpose involving improper charging on U.S. Navy shipbuilding contracts for the CG-47cruiser and DDG-61destroyer programs at Bath Iron Works Cor- poration, Bath, Maine. At the sametime, the Navy received similar alle- gations and beganlooking into them. In the interest of not duplicating the Navy’s efforts, the Chairman, Subcommitteeon Investigations, HouseCommittee on Energy and Commerce,requested that GAO review the Navy’s work to determinewhether the allegations were adequately covered.The Navy’s review was nearly completeas of April 1991.

Bath Iron Works has been a major shipbuilder in the CG-47cruiser and Background DDG-61destroyer programs for many years. Under these programs, Bath Iron Works has beenresponsible for design and engineeringwork under various servicesand construction contracts. Under servicescon- tracts, which are generally cost-reimbursable,it provides engineering and other servicesfor the ship programs. Under construction contracts, which are generally fixed-price incentive, it actually builds the ships. The Naval SeaSystems Command, Washington, D.C., and the Office of the Supervisor of Shipbuilding, Bath, Maine, are responsiblefor negoti- ating contracts and contract changesas well as for overseeingBath Iron Works’ performance. Proper allocation of labor chargesis important becauseof the differ- encesin the types of contracts. In general,on a cost-reimbursablecon- tract, the Navy pays the costs incurred under the contract; however, on a fixed-price incentive contract, the Navy pays a fixed amount, and the Navy and the contractor share costs if the fixed amount is exceeded.If costs that should be chargedto fixed-price contracts are chargedto cost- reimbursablecontracts, the Navy would pay more than it should. The anonymoussource alleged that a Bath Iron Works official was responsiblefor intentional mischargingof contracts and for inappro- priate actions on other contractual matters. Specifically, it was alleged that Bath Iron Works (1) incorrectly chargedlabor hours on the cruiser program and refused to agreeto certain contract adjustments,(2) chargedthe Navy for certain ripout and rework on the cruiser program that it had not done, (3) improperly chargedengineering labor hours on the destroyer program to a cost-reimbursableservices contract when they should have beencharged to a fixed-price incentive construction contract, and (4) did not provide the Navy accurate data to justify con- tract costs on a destroyer contract modification.

Page 2 GAO/NSIAD-91% Navy Shipbuilding ExecutiveSummary

Results in Brief On the basis of its analysis of the improper chargesand other problems disclosedin the Navy’s review of the allegations,GAO concludedthat the Navy’s oversight of contracts at Bath Iron Works was ineffective and contributed directly to the improper chargesand problems found. In addition, the Navy’s review of the allegationswas inadequate.

The Navy did find someimproper charges,and actions have beentaken to recover several millions of dollars in the cruiser and destroyer pro- grams. However, an accurate assessmentof improper chargesin the destroyer program will never be known becauseof significant data weaknesseson contract chargesat Bath Iron Works. Finally, the Navy did not exerciseproper stewardship of government funds becauseit restructured the fixed-price destroyer contract with Bath Iron Works without adequatelyjustifying that the $37 million it was paying was fair and reasonable.

Principal Findings

Deficiencies in the Navy’s The Naval Inspector Generalcontrolled the Navy’s review and issued Review reports basedprimarily on work performed by the Navy’s Office of the Supervisor of Shipbuilding in Bath, assistedby the DefenseContract Audit Agency. Despite the intentional or criminal nature of the allega- tions, the oversight office was tasked to review the allegations rather than a professional investigative organization. The DefenseContract Audit Agency did later refer certain matters to the Naval Investigative Service, which concludedthat no intentional mischarging had occurred.

GAO believesthat the primary reliance on the Office of the Supervisor of Shipbuilding at Bath to do the review presenteda conflict of interest, becausethe Office was responsiblefor overseeingthe activities at Bath Iron Works that were the subject of the allegations.Also, there was a conflict in Bath Iron Works becomingan active participant in parts of the Navy’s review.

GAO also found deficienciesrelating to planning, documenting,and reporting the results of the Naval Inspector General’sreview. For example, the Navy concluded,without adequatereview and documenta- tion, that the allegation on ripout and rework did not have merit.

Page3 GAO/NSIAD-91-86 Navy Shipbuilding Executive Summary

Despite the shortcomingsin the Navy’s investigation, the government will recoup an estimated $3.2 million as a result of the allegations.

l Two long-standingcontract disputes in the cruiser program have been resolved, leading to about $2.3 million in payments by Bath Iron Works to the Navy. . Improper labor time chargeson the destroyer contract were estimated at $2.5 million, meaningthe Navy will recoup about $500,000because of cost-sharingprovisions.

l The DefenseContract Audit Agency’s findings of inaccurate cost data on the contract modification led to a negotiatedsettlement of $384,000.

Full Extent of Improper Even though the Navy estimated that improper chargesamounted to Charges on the Destroyer $2.6 million on the destroyer contracts, GAO believesthe full extent of the problem will never be known. Recordswere not maintained in suffi- Contracts Cannot Be cient detail to accurately audit whether labor chargeswere proper. Bath Determined Iron Works’ engineeringdepartment personneldo not chargelabor hours to the preparation of an identifiable work product such as a spe- cific engineeringdrawing. Instead, labor chargesare made against a par- ticular contract. The limited data significantly impaired the scopeof a joint Navy/Defense Contract Audit Agency/Bath Iron Works audit and required assumptionsthat were inherently subject to question, thereby undermining conclusionsabout the amount of proper or improper charges.Moreover, Bath Iron Works’ instructions on which contracts to chargelabor costs were complex and contributed to problems in assessingimproper charges.

Restructuring of Destroyer The DefenseContract Audit Agency found that inaccurate cost data Contract Not Supported by supported the September1989 contract modification that dealt with specific technical issues.Another major part of the modification, Cost Data accountingfor $37 million of the $71 million potential modification cost, dealt with a restructuring of the contract. The restructuring combined the design and construction parts of the contract, raised the ceiling price, and changedthe cost-sharingratio betweenBath Iron Works and the Navy. The net effect of these changeswas to eliminate a potential loss the contractor faced on the original fixed-price contract terms. The restructuring was not supported with cost data. GAO believes,without adequatedocumentation, there are serious questions as to whether the decisionto restructure the contract was justified.

Page 4 GAO/NSIAD91-S5 Navy Shipbuilding Executive Summary

Ineffective Nav‘ y Oversight GAObelieves that the primary causeof problems disclosedin the review of Contracts at Bath Iron of the allegations was inadequateNavy oversight of contracts at Bath xxr,,1-, Iron Works. Most importantly, concerninglabor charges,the Navy w OPKS allowed a system to exist with minimum data on contract charges, despite a work environment in which engineeringdepartment employees work concurrently on both fixed-price incentive and cost-reimbursable contracts. At a minimum, under these circumstances,the Navy should have increasedits monitoring activities of contract chargeswhen the cost-reimbursablelead yard services contract was awarded.F ’urther- more, the Navy did not resolve internal control issuesraised by the DefenseContract Audit Agency related to proper labor chargesfor pro- duction workers.

GAOalso found other examplesof poor Navy oversight of contracts at Bath Iron Works. The Navy (1) allowed contractual disputes in the cruiser program to go unresolved for over 2 years and (2) maintained no data on what ripout and rework, if any, was actually incurred in the construction of cruisers.

Responsibility to substantiate proper contract chargesrests with Bath Recommendations Iron Works, and responsibility to ensurecompliance through appro- priate oversight activities rests with the Navy. GAObelieves that the stewardship of government funds requires the Navy to seekimprove- ments in the way Bath Iron Works chargescosts to contracts and the way it overseesBath Iron Works’ contract activities.

BecauseGAO'S review focusedon the Navy’s actions on specific allega- tions, GAOdid not perform sufficient work to enableit to recommend specific methods for improving data on contract charges.Nevertheless, GAObelieves that improvements are neededand recommendsthat the Secretary of the Navy, in conjunction with the DefenseContract Audit Agency and Bath Iron Works, provide improved controls over contract charges.GAO also recommendsthat the Secretary of the Navy review and strengthen oversight activities at Bath Iron Works through appro- priate measuressuch as increasedmonitoring activities, prompt atten- tion to contract issues,and improvements in internal controls.

As requested,GAO did not obtain official commentsfrom the Department Agency Comments of Defenseon a draft of this report. However, GAOdiscussed its findings with Navy and Bath Iron Works officials and their commentshave been incorporated where appropriate.

Page 5 GAO/NSIAD91-86 Navy Shipbuilding Contents

Executive Summary 2 Chapter 1 8 Introduction BIW Contracts for Cruisers and Destroyers 8 EngineeringServices on Construction and Services 9 Contracts Navy’s Award and Oversight of Contracts 9 AnonymousAllegations 10 Objectives,Scope, and Methodology 10

Chapter 2 12 Cruiser Program: Contractual Dispute Involving Ship Construction 12 contractual Issues and Dup~~~$~~pe of Work 14 Improper Charges Navy, DCAA, and BIW Identified Improper Charging in 16 the Cruiser Program

Chapter 3 16 Cruiser Ripout and Construction ChangesRelating to Anti-Air Warfare and 16 External Communications Rework: Insufficient Navy’s Review of the Allegation on Ripout and Rework 17 Data to Confirm or Navy Paymentsfor Ripout and Rework 18 Lack of RecordsShowing the Extent of Ripout and 19 Refute the Allegations Rework

Chapter 4 21 Destroyer Program: Why Proper ChargesAre Important 21 Navy’s Review of Allegation 21 Insufficient Data to Improper ChargesAlso Found on Subcontract 23 Establish the Extent With Gibbs & Cox ProblemsWith Charging Instructions 24 of Improper Charges Limited Data on Contract Charges 25 Conclusionsand Recommendation 28

Chapter 5 29 Issues Relating to the Navy and BIW Modify DDG-61Destroyer Contract 29 Navy and DCAA Review Labor Rates for the Contract 30 Destroyer Contract Modification Modification Contract Restructuring 32 Conclusions 35

Page 0 GAO/NSIAD-9146 Navy Shipbuilding Chapter 6 37 The Navy’s Review of Inadequate Navy Review of the Allegations 37 Need for Better Controls and Oversight at BIW 40 the Allegations and Its Conclusionsand Recommendation 42 Oversight of Contracts at BIW

Appendix Appendix I: Major Contributors to This Report 44

Abbreviations

BIW Bath Iron Works Corporation DefenseContract Audit Agency GAO GeneralAccounting Office SUPSHIP Office of the Supervisor of Shipbuilding

Page 7 GAO/NSIAD-91-85 Navy Shipbuilding Chapter 1 Introduction

The Bath Iron Works Corporation (BIW), Bath, Maine, has beenawarded U.S. Navy construction contracts for CG-47Ticonderoga class cruisers and DDG-61Arleigh Burke class destroyers as well as servicescontracts in which BIW provides engineeringand other servicesfor the respective ship classes.In October 1989,we received allegationsfrom an anony- mous sourcethat BIW improperly chargedlabor hours to servicescon- tracts when it should have chargedthem to construction contracts, Also, the allegations involved overchargingfor certain changesin construc- tion contracts.

BIW has beena contractor in two major Navy shipbuilding programs:the BIW Contracts for CG-4’7Ticonderoga class cruiser and the DDG-61Arleigh Burke class Cruisers and destroyer. As a follow shipbuilder,’ BIW has received contracts to con- Destroyers struct eight cruisers. The Navy also awarded BIW a follow yard services contract in January 1988to provide servicesthat pertain to the overall cruiser program. Except for the first cruiser, the construction contracts were fixed-price incentive contracts, and the follow yard servicescon- tract was a cost-plus-fixed-feecontract. BIW has delivered five cruisers and has three others under construction.

In April 1986,the Navy awardedBIW the contract for the design and construction of the lead ship (DDG-51)in the destroyer program. Since then, the Navy has awardedBIW four construction contracts for eight additional destroyers. It also awardedBIW lead yard servicescontracts, the first in June 1987,to provide servicesthat pertain to the overall destroyer program. The construction contracts were fixed-price incen- tive, and the lead yard servicescontracts were cost-plus-award-fee.The lead ship was delivered on April 29, 1991, and three other destroyers are under construction.

On the fixed-price incentive contracts, the Navy and BIW share costs dependingon the level of costs incurred under the contract. The Navy is responsiblefor costs incurred up to the contract target cost, or esti- mated contract cost. The Navy and BIW share costs over the target cost up to the ceiling price, which is the maximum contract price the Navy will pay, including profit, under the contract. For example, a contract with a 60/60 sharing ratio meansthat the Navy is responsiblefor the

‘For the cruiser and destroyerprograms, the leadshipbuilder designed and constructed the first ship of the class,and the Navy later held competitionfor a secondsource to constructthe ships(follow shipbuilderor follow yard). For cruisers,Ingalls Shipbuilding, Pascagoula, Mississippi, was the lead shipbuilderand BIW was the follow shipbuilder.Conversely, for destroyers,BIW wss the leadship builder and IngallsShipbuilding was the follow shipbuilder.

Page 8 GAO/NSIAD91445 Navy Shipbuilding - Chapter 1 lmroduction

target cost and 50 percent of costs betweentarget cost and the ceiling price. BIW is responsiblefor 50 percent of the costsbetween the target cost and ceiling price and all costs abovethe ceiling. The cost sharing ratios vary amongcontracts.

On the cost-plus-award-feecontract, the Navy pays costsjustified under the terms of the contract (cost-reimbursable),a basefee, and another fee that is determinedbased on the contractor’s performance.

BIW is responsiblefor engineeringservices under both the construction Engineering Services and servicescontracts for the cruiser and destroyer programs.On the on Construction and destroyer program, BIW designedthe lead ship under the lead ship con- Services Contracts tract and performed designand other engineering-relatedservices for the class of ships under the lead yard servicescontract. On the cruiser program, BIW performed servicesassociated with ship construction problems,as well as other work related to the cruiser classof ships under the follow yard servicescontract. Also, Gibbs& Cox, BIW’s design subcontractor, provided substantial amountsof designand engineering servicesunder the destroyer contracts. To avoid mischargeswithin the engineeringdepartment, closeattention is neededto accurately account for contract charges.An engineering department employee,on a daily basis, can perform tasks on both con- struction contracts and servicescontracts. In general,the servicescon- tracts are cost-reimbursableand the construction contracts are fixed- price incentive. If costs that should be chargedto fixed-price contracts are chargedinstead to cost-reimbursablecontracts, the Navy would pay more than it should.

The Naval SeaSystems Command is responsiblefor acquisition of ships Navy’s Award and and the oversight of contracts. The Command’sContracts Directorate, Oversight of Contracts and specifically the procuring contracting officer, are responsiblefor the award of the ship construction contracts and major changesto these contracts. The Command’sOffice of the Supervisor of Shipbuilding (suPsHIP/Bath),Bath, Maine, is responsiblefor overseeingBIW ’S perform- anceunder the various contracts and for negotiating certain contract changes.The DefenseContract Audit Agency (DCAA)office in Bath pro- vides audit and support servicesto assist the Command’sheadquarters and sunsurp/Bathin exercisingtheir oversight responsibilities.

Page 9 GAO/NSIAD91445 Navy Shipbuilding Chapter 1 Introduction

We received the allegations from an anonymoussource through GAO’S Anonymous “hotline,” which provides a meansfor peopleto disclosepotential fraud, Allegations waste, or abuseof governmentfunds. The Navy received similar allega- tions over its hotline. The anonymoussource allegedthat a BIW official was responsiblefor intentionally mischarging contracts and for inappro- priate actions regarding other contractual matters. The allegations of mischarging generally involved designand engineeringlabor charges, which have beenextensive over the past several years. The allegations are summarizedas follows:

Allegation #l-Cruiser Program Mischarges:BIW incorrectly charged labor hours to the cruiser follow yard services contract to mitigate cost overruns on several cruiser construction contracts. The anonymous sourcealleged that the company refused to agreeto contract adjust- ments associatedwith the investigation of ship construction problems. This allegation is discussedin chapter 2.

Allegation #2-Ripout and Rework on Cruisers: BIW overchargedthe Navy on cruiser construction contracts by including production labor hours for ripout and rework that did not occur. This allegation is dis- cussedin chapter 3.

Allegation #3-Destroyer Program Mischarges:BIW incorrectly charged labor hours to the destroyer lead yard services contract to mitigate cost overruns on the DDG-61lead ship construction contract. This allegation is discussedin chapter 4. Allegation #4-Destroyer Contract Modification: In September1989, the Navy and BIW modified the lead ship destroyer contract, which resolved outstanding contractual issuesand restructured the contract to increase the Navy’s share of costs. The anonymoussource questioned the pricing and negotiation of the modification and specifically allegedthat BIW did not provide the Navy with accurate data during negotiations.This alle- gation is discussedin chapter 6.

We beganour review of the allegations involving US. Navy shipbuilding Objectives, Scope,and contracts at BIW in November 1989.In December1989, the Chairman, MethodologyY Subcommitteeon Investigations, HouseCommittee on Energy and Com- merce,requested that we monitor the Navy’s work to ensurethat the allegationswere adequatelyreviewed. The Navy’s review, which began in October 1989,was essentially completeat the conclusionof our review in April 1991.

Page 10 GAO/NSIAD-91-85 Navy Shipbuilding Chapter 1 Introduction

In our review, we performed audit work to the extent necessaryto assessthe adequacyof the Navy’s review. Our work did not include a detailed independentreview of BIW records to identify improper contract chargesbecause of (1) the ongoingNavy review and (2) the data problems discussedin chapter 4 of this report.

We interviewed representativesof, and obtained data at, the Naval Sea SystemsCommand; the Inspector Generalof the Department of Defense; the Naval Inspector General;suPsmP/Bath; BIW; and DCAA(Bath, Maine). In addition to the audit work discussedin this report, the Chairman of the Subcommitteealso asked our Office of SpecialInvestigations to examine whether intentional mischarging was involved on the contracts that we reviewed. We neededaccess to BIW employeesto conduct this investigation. BIW offered to provide unobstructed accessto its employeesif we withheld discussingour findings with the Subcommittee until the investigation was complete,but this was not agreeablewith the Chairman. As a result, our Office of SpecialInvestigations could not con- duct the investigation for intentional mischarging. As the Navy’s investigation progressedand DCAAbecame involved, DCAA referred the areasthat our Office of SpecialInvestigations was attempting to investigate to the Naval Investigative Service. We did not assessits investigation. As requested,we did not obtain official agencycomments on this report. However, we discussedour findings with agencyand BIW representa- tives and have incorporated their commentswhere appropriate. We conductedour review betweenNovember 1989and April 1991in accordancewith generally acceptedgovernment auditing standards.

Page 11 GAO/NSIAD-91% Navy Shipbuilding Chapter 2 Cruder Program: Contmctual Issuesmd Improper Charges

The anonymoussource accused BIW of incorrectly charging labor hours to the cruiser servicescontract to mitigate cost overruns on several con- struction contracts. According to the allegation,BIW refused to provide contract adjustmentsassociated with the investigation of ship construc- tion problems.In early 1989,prior to the allegation,the Navy and BIW identified this contractual dispute, which was finally resolvedin March 1991. A secondrelated contractual issue concernedduplicate work required under separatecontracts. This issue,outstanding sinceJanuary 1988,was resolvedin August 1990. Resolutionof these contractual issuesresulted in contract adjustments of about $4.2 million. The Navy will recoup about $2.2 million because of the cost-sharingprovisions in the cruiser construction contracts. In addition to the contractual disputes, about $248,000in improper chargeswere identified in the cruiser program, which resulted in the Navy recoupingabout $124,000.

The Navy and BIW disagreedon whether the construction or follow yard Contractual Dispute servicescontract should be chargedfor the investigations that must be Involving Ship madewhen ship construction problems are identified. The dispute stems Construction Problems from a provision in the follow yard servicescontract awardedin January 1988. Problemssuch as interferencesbetween pipes and ventilation duct work occur during ship construction. Engineeringdepartment employees located near the construction site are called in to investigate such problems and prepare designcorrection reports that describethe problem. The Navy believesthat the investigation of the construction problems,when determinedto be BIw-responsible,lshould be chargedto the construction contracts. Secondly,the Navy believesthat the investi- gation of construction problems,when determinedto be Navy-respon- sible but only minor in nature, should also be chargedto the construction contracts. BIW believes,however, that the investigation of all construction problemsshould be chargedto the follow yard services contract. BIW representativesobjected to the Navy’s position by citing the wording containedin the follow yard servicescontract, which states

‘As part of the investigation,the engineerdetermines whether the constructionproblem is attribu- tableto a Navy designerror (Navy-responsible)or attributableto BIW designor constructionerrors (BIW-responsible).

Page 12 GAO/NSL4D-91-86 Navy Shipbuilding Chapter 2 Cruiser Program: Contractual Issues and Improper Charges

that BIW will “provide engineeringeffort required to develop and incor- porate design solutions to drawing problems identified by the con- tractor.” This provision, they said, allows them to chargesuch investigations to the follow yard services contract.

BIW representatives also said that this provision was similar to a provi- sion in the CG-51 cruiser construction contract, which authorized BIW to charge the investigation of drawing errors to the follow yard services contract regardlessof Navy or BIW responsibility. In addition, BIW issued charging instructions in April 1988that indicated its intention of charging the investigations to the follow yard services contract. BIW believesthat the Navy’s 2-year acceptanceof these charging instruc- tions validates its position.

Navy representativessaid that BIW has incorrectly interpreted the con- tract language,taking it out of context. They stated that, becausethe languageis under the section entitled “Navy changecontrol process,” it is unrelated to BIW-responsibleconstruction problems.

As a result of a contractual settlement on a request for equitable adjust- ment in 1987,contracts were modified to include languagethat the Navy believessupports its position, accordingto Navy representatives.More- over, the modifications also defined “minor” and included languagethat the Navy says suggestsinvestigations of “minor” Navy-responsible designchanges are chargeableto the construction contracts. In general, the Navy believesthat it has prepaid for these services as part of the price for the construction contract.

Navy representatives dispute BIW’S assertion that the Navy had acceptedthe company’scharging instructions for over 2 years. They maintain that the Navy never approved the charging instructions, and no documentationexists that would establish that Navy representatives ever agreedto allow the company to chargethe investigation of BIW- responsibleconstruction problems under the CG-51 contract. According to Navy representatives,only the investigation of construction problems determined to be Navy-responsiblewas allowable under the CG-51 contract. As part of the current review, in May 1990,suI?sHIP/Bath provided written notification to BIW of the Navy’s intent to disallow about $3.1 million in estimated costs under the follow yard services contract related to the invest:igationof BIw-responsibleconstruction problems. In September1990, BIW submitted a proposal of $2.1 million to settle the

Page 13 GAO/NSLAD91-86 Navy Shipbuilding Chapter 2 Cruiser Program: Contractual Issues and Improper Charges

dispute. The proposal was basedon the premise that BIW should pay for Brw-responsibleconstruction problems and the Navy should pay for Navy-responsibledefects. The matter was resolved in March 1991,and BIW transferred about $2.4 million in costs from the follow yard services contract to the construction contracts. According to a suPsHIP/Bathrep- resentative, the agreementresulted in Navy savings of about $1.2 million becauseof SO/SOcost-sharing provisions betweenthe Navy and BIW in the construction contracts.

The secondcontractual issue involves an overlap in responsibilities Duplicate Scopeof under certain cruiser construction contracts and the follow yard ser- Work vices contract. The construction and services contracts contain duplicate scopeof work descriptions related to areas such as (1) establishing and maintaining an office in Washington,D.C., for liaison activities between BIW, the Navy, and Ingalls Shipbuilding and (2) maintaining drawings and specifications for the cruiser class of ships. The matter was resolved as part of the current investigation in August 1990when the Navy and BIW agreedto price reductions in cruiser construction contracts. Although the Navy was aware of the problem with the duplicate scope of work, it awardedthe follow yard services contract without resolving the issue. In September1987, BIW submitted a price proposal to reduce the price of the construction contracts for the value of the duplicate scope.At the request of the Naval SeaSystems Command, BIW revised the proposal three times, but the parties reachedno settlement before the Navy awardedthe follow yard services contract. The Command’s procuring contracting officer decidedto award the follow yard services contract in January 1988and later negotiatethe credits to the construc- tion contracts. Commandrepresentatives said that the final settlement on the duplicate scopeissue was believed to be a routine matter, so the procuring contracting officer negotiatedthe follow yard services con- tract without resolving the problem. In January 1989,the Commandauthorized suPSHIP/Bathto negotiate the resolution of the matter. However, it was not until August 1990(subse- quent to the allegation) that the Navy and BIW agreedto reducethe target prices on several cruiser construction contracts by about $1.8 million. According to SuPsHIP/Bathrepresentatives, this agreement resulted in a Navy savings of about $1 million in cost and profit because of the cost-sharingprovisions betweenthe Navy and BIW in the construc- tion contracts. They attributed the delay in resolving the issue to the complexity of the negotiationscreated by negotiating this issue along

Page 14 GAO/NSIAD-91-86 Navy Shipbuilding Chapter 2 Cruiser Program: Contractual Leeuee and Improper Charges

with the disagreementover chargesfor the ship construction problems investigation.

Unlike the investigation of ship construction problems in which the Navy, DCAA, and BIW Navy and BIW disagreedon who should pay to resolve the problems,the Identified Improper Navy and BIW agreethat the preparation of drawing revisions and revi- Charging in the sion notices should be chargedto the construction contracts if the design problem is BIW-responsible.Following the anonymousallegations, the Cruiser Program Navy, DCAA,and BIW reviewed time chargesfor the preparation of cer- tain drawing revisions and revision notices and identified improper chargesamounting to about $221,000.These results were basedon con- siderable assumptionsbecause of existing data on contract charges. (Similar problems affected the destroyer program, as discussedin chapter 4). In addition, the Navy identified improper chargesof about $27,000for the preparation of waivers and deviations, which are docu- ments used by the contractor to request a waiver or deviation from con- tract specifications. BIW has agreedthat these chargeswere improper and has transferred the chargesfrom the cost-reimbursableservices contract to the fixed-price construction contract. As a result, the Navy will recoup about $124,000.

Page 15 GAO/NSIAD91-86 Navy Shipbuilding ,, ,,,,,*,,,

Chapter 3 Cruiser Ripout and Rework: Insufficient Data to Confirm or Refute the Allegations

For certain cruiser construction changes,the anonymoussource alleged, amongother things, that the Navy paid for ripout and rework that did not occur. After a limited review, the Navy dismissedthe allegation, having concludedit had no merit. However, we believe that insufficient information is available to confirm or refute the allegation. For these changes,it is not possibleto determinethe amount that the Navy paid for ripout and rework or the extent that ripout and rework was actually performed.

After contract award, the Navy often requires changesto the planned Construction Changes construction of the ship. The principal construction changescited in the Relating to Anti-Air allegation were anti-air warfare and external communications,two of Warfare and External the largest modifications implementedduring the cruiser construction program. Thesechanges involved more than 500 revisions (revision Communications notices) to the ship’s drawings. The anti-air warfare changeupgraded the radar capabilities, and the external communicationschange required installation of improved cable and wiring throughout the ship. Ingalls Shipbuilding, the lead shipbuilder in the cruiser program, pro- vided BIW with the supporting designdata (drawings and other engi- neering data) required to implement both changes.Initially, the Navy authorized BIW to begin work on these changeswith maximum-priced modifications to avoid scheduledelays. A maximum-pricedmodification sets a not-to-exceedprice for the change;the exact price is negotiated later. Subsequently,BIW estimatedthe cost of implementingchanges, prepared price proposalsbased on these estimates,and submitted these proposalsto the Navy. The Navy and BIW eventually negotiatedthe price for the proposal.

The Navy authorized BIW to begin start-up work on the anti-air warfare changein November 1984 and authorized about $20 million under a maximum-pricedcontract modification in December1987. In October 1988,BIW submitted an anti-air warfare proposal for $12.5 million, which was negotiateddown to about $10 million in June 1989. For external communications,the Navy signeda maximum-pricedmodifica- tion for $11.6 million in December1987. BIW submitted an external com- munications proposal for $3.7 million in October 1988,which was negotiateddown to about $2.8 million in May 1989. According to suR%nP/Bathrepresentatives, the transmission of the designdata from Ingalls Shipbuilding to BIW was slow and sporadic

Page 16 GAO/NSIAD-91-95 Navy Shipbuilding Chapter 3 Cruiser Ripout and Rework Iuaufflcient Data to ConfIrm or Refute the Allegations

becausethe designsfor these changeswere still evolving and were fre- quently revised. For several years, BIWdelayed the preparation of price proposals until it received enoughdesign data from Ingalls Shipbuilding to estimate the costs involved. Consequently,most of the construction had beencompleted when BIW beganto develop the price proposals,

Ripout occurs when previously installed materials are removedto accomplisha construction change;rework occurs when workers must repair the area affected by a ripout. The amount of ripout and rework dependson the timing of the change.If the changework is performed within the time frame for the original scheduledconstruction activity, little or no ripout and rework is necessary.Conversely, if the changeis made after this period, considerableripout and rework may be required, dependingon the extent of the change.

Navy’s Review of the To provide greater independenceand credibility in its investigation on the allegation, suPSHIP/Bathrequested assistance from the SUPSHIP office Allegation on Ripout in Groton, Connecticut.suPsmP/Groton assigned an experiencedcontract and Rework administrator who managesa major shipbuilding program. Over a 2-weekperiod at suPsHIP/Bath,the reviewer interviewed SUPSHIP/Bath and BIW personnel,examined contract documents,and reviewed produc- tion and other records. He concludedthat the allegation was unsubstan- tiated. The Naval Inspector Generalconducted a brief review and acceptedthe Navy reviewer’s conclusionswithout performing additional work.

The reviewer tried to determine whether the ripout and rework was actually performed. He reviewed 13 of the 500 revision notices processedduring the anti-air warfare and external communications changesby comparing the ripout and rework from the revision notices with BIW production and schedulingrecords. Theserecords were the detailed planning and production records used by the contractor to scheduleand perform the tasks required to build a ship. The reviewer attempted to reconstruct the situation using the production and sched- uling records, even though they were not intended for this purpose. Basedon this, he rendered an opinion on whether ripout and rework was actually performed. Basedon this review, he concludedthat 1 of the 13 revision notices appearedto include unnecessaryripout and rework, though it was impossibleto determine for sure whether the ripout and rework actually occurred. He did not select additional revision notices for review,

Page 17 GAO/NSIAD9186 Navy Shipbuildiug Chapter 3 Cruiser Ripout and Rework IumfTicient Data to Confirm or Refute the Allegations

despite the findings in this one case,yet concludedthat there was no evidenceBIW had chargedthe Navy for ripout and rework that had not occurred.

The anonymoussource also allegedthat BIW held up designdocuments for these changesover long periods, causingunnecessary ripout and rework. To determine whether designdocuments were transmitted to the production departments in a timely manner,the Navy reviewer chosea nonrandomsample of 59 revisions from 3 changesnot men- tioned in the allegation. He comparedreceipt dates for design data from Ingalls Shipbuilding with the dates that the revisions were issued to the BIW production departments.The Navy reviewer was unable to draw a conclusionthat would indicate deliberate hold up of designdata.

The anonymoussource also allegedthat BIW overchargedthe Navy for class II engineeringchange notices, which were minor changesgenerated by the lead shipbuilder (Ingalls Shipbuilding) to accommodateprior major changes.The Navy reviewer said he did not examine class II engi- neering changenotices becausea suPSHIP/Bathrepresentative told him that there was little or no ripout and rework associatedwith these changes.However, other supsHxP/Bathand BIW representativestold us that, as a rough estimate, $10 million to $15 million in class II engi- neering changenotices were processed;about 25 to 50 percent of this amount was for ripout and rework. They also said that considerable time and effort would be required to identify the total value of the class II engineeringchange notices and the ripout and rework associatedwith them.

We believe that the Navy’s review of these allegations had deficiencies. For example,the Navy reviewer developedconclusions based on inade- quate samplesand placed reliance on unsubstantiated testimonial evi- dence.His supporting evidencedid not contain any records of interviews and lacked essential documentsprovided by BIW but later returned to them.

Navy payments for ripout and rework were indeterminable for the anti- Navy Payments for air warfare and external communicationschanges. BIW did not specifi- Ripout and Rework cally identify the amount of ripout and rework required to complete ” each changein its proposals.Moreover, the prices for these changes were negotiatedon a bottom-line basis. In a bottom-line settlement, indi- vidual cost elements,such as labor hours and overhead are not negoti- ated. Therefore, individual cost elementsare left undefined. There is no

Page 18 GAO/NSIAD-91-85 Navy Shipbuilding Chapter 3 Cruiser Jtlpout and Rework Imufflcient Data to Cadlrm or Refute the AUegatione

record, or final estimate, of what the Navy paid for cost elementssuch as ripout and rework.

BIW doesnot collect actual cost data for contract changes,either in total Lack of Records or separately by individual cost elementssuch as ripout and rework. It Showing the Extent of estimated the costs of anti-air warfare and external communications Ripout and Rework basedon production and schedulingrecords. According to suPsHIP/Bath representatives,they have occasionally directed BIW to collect cost data for small changes,but did not for anti-air warfare and external commu- nications becauseof their size.

BIW and suPsmP/Bathrepresentatives said that it is not practical to col- lect data on the cost of construction changes(or ripout and rework) becausechange work cannot be separatedfrom regular ongoingwork. For example, the painter of a ship’s compartment would have difficulty separating the costs associatedwith the contract changeoccurring in the compartment (such as the relocation of ventilation equipment) from the overall construction of the compartment that would have beendone regardlessof the change.In addition, BIW and SuPsHIP/Bathrepresenta- tives believe the cost of collecting this data would outweigh its benefit.

BIW representativesbelieve that only minimal ripout and rework occurred in connectionwith the anti-air warfare and external communi- cations changes.They stated that ripout and rework were minimized becausethe changework was integrated with little disruption in the reg- ularly scheduledconstruction. Although detailed supporting data does not exist, they estimated that ripout and rework on the changeswere very small, about $200,000,for contract changesnegotiated at about $13 million. Thus, the BIW representativesbelieve that the allegation has no merit.

Neither BIW nor suPsmP/Bathhad construction records showing the extent to which ripout and rework had actually occurred. The Navy monitors the physical progressof the ship’s construction to determine what progresspayments should be madeto BIW. However, the suPsHIP/Bathrepresentatives in chargeof this activity told us they have four peopleobserving the company’sprogress and these employeesare not expectedto collect the detailed data required to evaluate change proposals. In our opinion, the lack of data is a weaknessin the Navy’s oversight of contracts.

Page 19 GAO/NSLAD-91435 Navy Shipbuilding chapter 8 Cruber llipout and Rework hunffkient Data to ConfIrm or Befhte the Allegatlonm

According to DCAArepresentatives, DC~A has beenconcerned for several years that BIW doesnot collect actual cost data on individual contract changesas a routine matter. They said that the data could be used to assist DCAAand the Navy in evaluating costs for various BIW proposals.

Page 20 GAO/NSIADol-& Navy Shipbuilding Chapter 4 Destroyer Program: Insufficient Data to Establish the Extent of Improper Charges

The anonymoussource alleged that BIW incorrectly chargedengineering labor hours to the destroyer servicescontract rather than to the destroyer construction contract. A joint review of the allegation by the Navy, DCAA,and BIW indicated that improper chargesdid occur, which are estimated at about $2.5 million.

We believe an accurate assessmentof improper chargeswill never be known becauseof the complexity and ambiguity of the time charging instructions and becauseBIW maintains only limited data on contract charges.We are concernedthat the Navy allowed a work environment to exist at BIW where time chargeswere not carefully compiledor indepen- dently checked.Although BIW has agreedto repay the Navy for these estimated improper charges,the Navy and BIW needto improve their controls over time chargesto prevent recurrencesof the problem.

To understand improper charges,it is important to understand the dif- Why Proper Charges ferencesin requirementsfor the lead ship construction contract and the Are Important lead yard servicescontract. Under the April 1985lead ship contract, BIW was responsiblefor preparing the construction drawings for the DDG-51 lead ship. Under the June 1987 lead yard servicescontract, BIW assumed responsibility for designwork related to the destroyer class of ships oncethe lead ship designwas complete.Because the lead ship contract was fixed-price incentive and the lead yard servicescontract was cost- plus-award-fee,proper charging of labor hours is important. Labor hour mischargesshould be determinedby comparing,for specific tasks, which contract the employeeshould have charged(based on con- tract provisions and charging instructions) with the contract the employeedid charge.

A After receiving the allegations,sursHIP/Bath representatives, assisted by Navy’s Review of DCAA,began their review. The investigation included, amongother Allegation things, a sampleof time chargesfor drawing revisions. Basedon this review, mischargingwas cited in the Naval Inspector General’sMay 1990report. The report attributed the mischargingto several causes, including erroneousBIW charging instructions to employeesand ambigui- ties in contract terms and conditions.

Meanwhile, BIW reported the results of its own internal audit. BIW identi- fied instancesof improper chargesby designersand supervisors,but found no evidencethat it was intentional. According to the company’s

Page 2 1 GAO/NSIAD-91-95 Navy Shipbuilding cbapta 4 Destroyer Program Inmffldent Data ta JMabli#h the Extent of Improper Chargea

April 1990 report, the improper charges were due to mistaken interpre- tations of what each contract required. Someworkers did not receive charging instructions, and others did not understand attempts by BIW managers to clarify the instructions. The report did not provide a dollar estimate of the extent of improper charges, but contended that it was unlikely that charging errors were significant.

In April 1990, representatives of SUpSHIP/Bath,DCAA, and BIW began a joint audit of alleged improper charges.The audit expanded on suPSHIP/Bath’priors work and reviewed charges involving (1) drawing revisions, (2) design correction requests, (3) revision notices, and (4) supervision charges. The review for improper charges on a drawing had to be limited to its revisions, since prior to the first revision on each drawing, data does not exist to determine which employeesworked on the drawing and when the work wan done. The joint audit team made certain assumptions becauseof limitations in BIW’Sdata on cost charges. It established error rates from a review of samples,applied the error rates to the universe of various tasks, such as revision notices, and estimated improper charges based on average hours estimated to complete the various tasks. DCAAprepared audit reports that summarized the results of the joint audit. In these reports, DCM qualified the results of the audit based on the assumptions. In a series of reports ending in February 1991, the joint audit estimated that Bath Iron Works charged $2.5 million to the lead yard services con- tract that it should have charged to the destroyer lead ship construction contract. Based on this amount, the Navy will recoup about $500,000 becauseof the contract’s 80 percent/20 percent cost-sharing provisions. This excludes improper charges associatedwith BIW’Ssubcontract with Gibbs & Cox, which BIW identified before the receipt of the allegations.

BIW participated in the audit, according to suPSHIP/Bathrepresentatives, becauseof the complexity of BIW’S labor charging system and SUPSHIP/Bathdid not want to have charges transferred between con- tracts without BIW’s participation and concurrence in the process. According to BIW representatives, the company participated in the joint review to prevent errors if suPsHrP/Bathand DCAAconducted the review alone.

Page 22 GAO/NSIAD-91-&3 Navy Shipbuilding Chapter 4 Destroyer Program InsufRcient Data to Eet.abUh the Extent of Improper Charges

Prior to the investigation of the allegations,BIW had identified additional Improper Charges mischarging that occurred on its subcontractswith Gibbs & Cox. Gibbs Also Found on & Cox is responsiblefor providing engineeringservices in the destroyer Subcontract With subcontracts dependingon the nature of the work. Gibbs & Cox Basedon discussionswith Gibbs & Cox concerningan increasein work on a production support subcontract, BIW subcontract administration personnelquestioned charges for the subcontract. After discussionsand meetingsconcerning potential mischarging,BIW issued charging instruc- tions to Gibbs & Cox in August 1989for the lead yard services contract. In October 1989,based on the charging instructions, Gibbs & Cox’s iden- tified about 44,200 manhours that employeescharged between February and September1989 to a lead yard services subcontract that should have beencharged to the production support subcontract. In December1989, Gibbs & Cox increasedthe estimate of mischarging to about 47,000 man hours. In January 1990,after an in-depth review, BIW transferred about $1.5 million from its lead yard services prime contract with the Navy to its lead ship contract. This transfer decreasedthe Navy’s payments to BIW by about $300,000because of the contracts’ cost-sharingprovisions.

The improper chargesrelated to the resolution of ship construction problems. As BIW engineersreviewed problems that occurred during con- struction of the ship, it often called in Gibbs & Cox to help resolve these problems. Gibbs & Cox would investigate the construction problem, assist in developingengineering solutions, prepare the revision notices to correct the drawings, and correct the engineeringdrawings for the class of ships. According to Gibbs & Cox representatives,the improper chargesoccurred becauseGibbs & Cox chargedthe developmentof engi- neering solutions and the preparation of the revision notices to the lead yard services subcontract rather than the production support subcontract.

Gibbs & Cox representativesmaintained that the BIW charging instruc- tions issued in August 1989were in conflict with previous charging instructions orally provided by senior BIW management.The improper chargesdid not becomeapparent until after Gibbs and Cox received the August 1989written charging instructions. Becauseof the potential for fraud or unlawful activity in this matter, XAA referred it to the Naval Investigative Service in late January 1990.The Naval Investigative Service’sinvestigation did not discloseany evidencethat BIW’S senior

Page 23 GAO/N&W-91-96 Navy Shipbuilding Chapter 4 IhMroyer Program: lnmfflcient Data to Establish the Extent of Improper Charges

managementissued verbal instructions that led to intentional mischarging.

Charging instructions, basedon contract requirements,form the basis Problems With for the specific contracts an employeeshould charge for specific activi- Charging Instructions ties. Accurate and clear charging instructions are essential for proper contract charges.This is especially important in BIW’S destroyer work, where employeeswork side by side and intermittently on both fixed price and cost reimbursable contracts. Although the Navy had approved BIW’Scharging instructions for the lead yard services contract on the destroyer program, these instructions were complex and contributed to problems in assessingimproper charges.

BIW developedcharging instructions for the lead yard services contract with input from its various departments.According to BIW representa- tives, chargesto the lead yard services contract were straightforward during the first year of implementation. However, charging questions arose in early 1988,and the company formed a working group from various departmentsto review the questions.Considerable debate occurred over the meaningof the languagecontained in the contract. In September1988, BIW issued its charging instructions, and in February 1989,the Navy’s contracting officer approved it.

Oncethe allegations made against BIW cameunder review, however, dif- ferencesbetween the Navy and BIW interpretations of the charging instructions emerged.One important charging issue involved differenti- ating betweenthe time that a drawing transitions from a lead ship drawing (chargeableto the lead ship contract) to a DDG-51class drawing (chargeableto the lead yard services contract). Also, the Navy and BIW identified circumstancesnot covered by the charging instruc- tions in which they disagreedon proper charging.

For example, BIW and the Navy disagreedon the amount of chargeson certain minor changesidentified during the construction process.BIW believed that someminor changeswould never require a formal revision to the drawing, or the revision could be accomplishedmuch later. Becausethese drawing revisions were revised immediately to accommo- date the follow shipbuilder in its construction of the follow ship, BIW believed that chargesfor incorporating these minor revisions in the drawings should be made to the lead yard services contract. However, the Navy believed that, becausethe revision is necessaryto correct the lead ship, then the chargeshould be to the lead ship contract. According

Page 24 GAO/NSIADsl-86 Navy Shipbuilding Chapter 4 Destroyer Program: Insufficient Data to Eetablleh the Extent of Improper Charges

to both the SuPsHIP/Bathand BIW representatives,this situation is not covered by the charging instructions or any other written documents. The charging instructions by their nature can be confusing to the designer.One example involves revisions occurring after the drawing has beenissued to the production department. If the developmentof a revision notice addressesa problem with the original lead ship design, then that chargeshould be to the construction contract, but the work of putting the information from the revision notice onto the drawing (drawing maintenance)should be chargedto the lead yard services con- tract. If the revision only involves follow ships, then the revision notice developmentand drawing maintenancecharges both belongto the lead yard services contract.

BIW records were not maintained in sufficient detail to accurately audit Limited Data on whether labor chargeswere proper. BIW engineeringdepartment per- Contract Charges sonnel do not chargelabor hours to the preparation of an identifiable work product such as a specific drawing. Instead, labor chargesare made against a particular contract, and engineeringpersonnel may work on different contracts, even during the sameday. The joint audit included a review of drawing revisions, revision notices, and designcorrection requests.A drawing contains somedata on each of its revisions, including the date of completion of the revision, the initials of the draftsmen and supervisors, and a brief description of the change. Similar data exists on designcorrection requestsand revision notices. By making certain assumptions,this type of data was used as a basis for the joint audit. The joint team neededto make considerableassumptions and judgments in its methodologies.For example,the employee’stime required to com- plete a task, such as a revision notice, had to be estimated. Also, although a document contained a date,judgments were made as to the length of the period the documentwas worked on. Most importantly, if the employeecharged a reasonableamount of time to the proper con- tract during the period, then an assumption was made that the time chargedwas for the specific task. Further, basedon samples,projections were made on the total amount of improper chargesin the program.

Page 26 GAO/NSIAlMl-SS Navy Shipbuilding Chapter 4 Deetmyer Pmgramz IwuMcient Date to Establinh the Extent of Improper Charges

Relationship to Cost Contract cost chargesare accumulatedfor government contracts Control and Accounting through the cost and schedulecontrol system. A series of cost reports, including the cost performance report, are generatedfrom this manage- Systems ment information system. According to DCAArepresentatives, this system provides the costs that are incurred under the contracts, including labor charges,but is not designedto identify improper con- tract charges.The system may show trends in the cost chargesthat could becomethe basis for reviewing cost charges.

BIW’S accountingsystem must comply with cost accountingstandards prescribed by the Cost Accounting StandardsBoard. According to DCPLA, DCAAhas someoutstanding issuesregarding BIW compliancewith the cost accountingstandards, but these issuesare consideredinsignificant. DCAArepresentatives further said that improper charging often involves an incorrect decision by an employeeto chargeone contract over another contract, which is unrelated to the accountingsystem that is in place.

Improper Charges on suPsHIP/Bath,DCAA, and BIW agreedthat improper chargesin supervision Supervision -An Example occurred becausea memorandumwith erroneouscharging instructions circulated within BIW. Four methodologieshave beenused since the of Difficulty in Assessing receipt of the allegationsto estimate the extent of improper charges. Improper Charges The methodologiesused considerableassumptions and judgments and demonstratethe difficulty in assessingthe extent of improper charges with the existing data at BIW.

In August 1988,a BIW vice president in the engineeringdepartment issued a brief memorandumthat was interpreted to mean that, under certain circumstances,supervisors should charge 100 percent of their time to the lead yard services (cost-reimbursable)contract. In October 1988,the memorandumwas withdrawn and supervisors were instructed to charge labor hours accordingto charging instructions issued by BIW in September1988. These instructions direct supervisors to discretely chargeeach contract in accordancewith the work performed.

According to BIW representatives,the August memorandumresulted in confusion and improper chargesby supervisors in the engineering department. Although the memorandumwas withdrawn, many supervi- sors continued to chargeall their time to the lead yard services contract. Becauseof the potential for fraud or unlawful activity, DCAAreferred the matter to the Naval Investigative Service in late January 1990.The investigation did not discloseany intentional mischarging.

Page 26 GAO/NSIAD-91-85 Navy Shipbuilding Chapter 4 Destroyer Pmgram: Insufficient Data to Establish the Extent of Improper Charges

The four methodologiesused to try to assessthe extent of mischarging are describedbelow. First Audit Methodology-sursmP/Bath representativesdeveloped a methodology in their preliminary review to assesswhether mischarging had occurred. They reviewed a sample of drawing revisions for supervi- sors’ labor chargesbased on the date the supervisor’s signature appearedon a drawing revision. If the chargesfor the revision should have beento the lead ship contract, but the supervisor chargedall time for the day to the lead yard services contract, then a mischargewas consideredto exist. According to suPsHIP/Bathrepresentatives, 19 of 21 sample caseswere improperly charged.suPsHIP/Bath representatives estimated the amount of improper chargeswas between$500,000 and $700,000,based on the trends in the number of supervisors charging 100 percent of their time to the lead yard services contract. SecondAudit Methodology-BIw performed its own internal audit of supervision charges.It identified employeeswith large blocks of time chargedto lead yard services,estimated the percentageof time split amongcontracts for each of these employees,and calculated how much time was incorrectly chargedbased on the actual number of hours charged.BIW estimated that 4,268 hours, or about $116,000,were improperly chargedby supervisors. The percentageof time split among contracts was a judgmental estimate not basedon factual data. Third Audit Methodology-The joint audit team estimated the amount of improper chargesfor supervision basedon the assumptionthat supervisory time chargesshould relate directly to the work produced by employeesunder their supervision. SuPsHIP/Bath(1) estimated the total work for the department and the percentagesof time (using certain judgmental weighing factors) betweenlead ship and lead yard services contracts and (2) comparedthe resulting data with actual time charges for the department. The estimate of improper chargeswas between $400,000and $500,000.BIW did not concur with certain suPsHIP/Bath assumptions,and the joint audit team discardedthe analysis.

Fourth Audit Methodology-The joint audit team decidedthat the extent of improper chargescould only be determinedby reviewing spe- cific work documentsand comparing them with actual labor charges. Certain assumptionshad to be used becauseBIW ’S labor system doesnot identify labor chargesto a specific work product. Labor chargeswere reviewed for a 3-day period: the day before the supervisor’s approval of the document,the day of the approval, and the day after the approval.

Page 27 GAO/NSLAD-91-86 Navy Shipbuilding Chapter 4 Destroyer Program; InsuffIcient Data to Establish the Jkmnt of Improper Charges

Any labor chargesmade to the proper contract during the 3-day period was consideredto be a correct charge,even though no method exists to determine whether the chargewas for the supervision of the specific document.suPsHIP/Bath estimated an averageof 1 hour of supervision to completea review. On the basis of the error rates in a sample of 100 work products, the joint team projected improper chargesof about $293,000.On the basis of this amount, the Navy could recoup about $58,600,because of the cost-sharingprovisions in the contract.

BIW Comments on Data BIW representativessaid the Navy has not required more detailed data Requirements on Contract on contract charges,and the nature of the shipbuilding work doesnot lend itself to such record-keeping.A requirement to record labor charges Charges to specific documents,such as a drawing or a revision notice, would create a severe administrative burden. They believe that such a require- ment would not be cost-effective.

Although the Navy’s review stemming from the allegation resulted in Conclusions and estimated improper charging on the destroyer lead ship contract of Recommendation about $2.5 million, we believe the true extent of improper charging will never be known. This is becauseBIW ’S charging instructions are complex and ambiguousand its time chargesystem provides only limited data.

We believe the Navy in these circumstancesneeds to take action to ensurethat the government’sinterests are adequatelyprotected. In addition to the improper engineeringcharges identified in the Navy’s review and the improper chargesfound at Gibbs & Cox on the destroyer program, DCAAhas sought changesfor many years in BIW’S time charging practices for production workers, but BIW has not modified its system (seech. 6). We recommendthat the Secretary of the Navy, in conjunction with DCAA and BIW, provide improved controls over BIW’S charging system. This would include a combination of better data on contract chargesas well as extensive monitoring of contract chargesthrough employee floorchecks.

Page 28 GAO/NSIAD-9186 Navy Shipbuilding Chapter 6 IssuesRe lating to the Destroyer Contract Modification

In September1989, BIW and the Navy negotiateda modification to the DDG-61contract that could increasethe Navy’s payments to BIW by as much as $71.7 million over the expectedlife of the contract. Part of the modification coveredtechnical issuesfor which BIW provided detailed cost and pricing data. Another portion of the modification, covering about $37 million of the increase,restructured the contract to increase the ceiling price and changethe cost-sharingprovisions. This portion was basedon generalstatements by BIW about the technical difficulty of meetingthe contract requirementsand was not supported by detailed cost data.

The anonymoussource alleged that BIW did not provide the government with accurate data during negotiationsof the technical issues.A DCAA review of this allegation performed at the Navy’s request resulted in about $384,000being returned by BIW.

We believe the more important issue in this modification, however, is the restructuring, which was agreedto by the Navy without detailed supporting cost data. In our January 1990report, which first reported on this restructuring, we expressedconcern that this could serve as a precedentfor other shipbuilders having difficulty meetingfixed-price contracts. We continue to be concerned,and we believe the Navy, before approving the modification, should have required sufficient cost data from BIW to assureitself that the cost adjustmentsin the modification were fair and reasonable.

Beginningas early as 1987,BIW was experiencingdelays and cost Navy and BIW Modify growth on the program that led it to seekchanges in the DDG-51con- DDG-51 Destroyer tract. BIW believedthat the fixed-price contract was not a suitable Contract vehicle for designingand constructing a technically sophisticatedlead ship in a new destroyer program. According to BIW, too many unknown technical challengesexisted to be workable under a fixed-price incentive contract. BIW’SChairman told us that he had askedthe Navy to change the contract to cost-reimbursablebut had beenturned down.

In March 1989,BIW submitted a proposal to modify the contract to resolve someoutstanding technical issuesand establish a new ceiling price and cost-sharingarrangement. In April 1989,BIW wrote the Navy, stressingits financial difficulties and requestinga special payment of $12 million to help relieve cash flow shortcomingspending approval of the modification. Even though the Navy did not act on the cash request, it did move aheadto modify the contract. The Navy requestedand

Page 29 GAO/NSIAJ%91-S5 Navy Shipbuilding Clulpter 6 IeeUeS IWdng to the Deetroyer Contract Modification

received more information from BIW on the technical issues,prepared a prenegotiation position paper, obtained a legal opinion, and entered into negotiations with BIW.

The contract modification was signedon September15, 1989.It pro- vided BIW about $3 million less than it requestedon the technical issues, and it generally adopted BIW’Sproposal for the restructured ceiling price and cost-sharingformula.

At the time of the negotiations,BIW was experiencinglosses on the con- tract that were estimated to reach $41.5 million. The technical adjust- ments, along with the restructuring changes,would eliminate those losses.The contract modification called for increasing the target cost by $31 million and target profit by $3.7 million. In addition, the restruc- tured portion of the contract modification could increasepayments to BIW by another $37 million if the price reachesthe new ceiling. The agreementcombined the design and construction portions of the con- tract and set a new ceiling price of about $530 million for the combined designand construction activities. It also changedthe cost-sharing formula for costs incurred betweenthe target and ceiling prices.

The Navy and BIW believed this contract modification representeda fair and reasonableresolution of the contract issuesand put the DDG-51 program in a position to produce a high quality ship with no further scheduledelays.

According to the allegation received by the Navy, the anonymoussource Navy and DCAA suggestedthe Navy review labor and overheadrates for the contract Review Labor Rates modification. We received a different allegation in which the anonymous for the Contract source allegedthat BIW did not provide the governmentwith accurate Modification data during negotiations of the modification, Prior to the modification and the allegation, the Navy waived a DCAA audit of the BIW proposal. However, suPSHIP/Bathand the Naval Sea SystemsCommand conducted separate technical analysesof the pro- posal, which included a review of BIW labor hours and material costs. The contracting officer said that sufficient information existed to nego- tiate the modification becauseof the technical analysesand existing agreementson labor rates.

Page 30 GAO/NSIAD-91-86 Navy Shipbuilding Chapter 6 Issues Relating to thL Destroyer Contract Modification

In responseto the allegation received by the Navy, a SUPsHIP/Bathcon- tract administrator reviewed the labor and overheadrates in the con- tract modification. The Navy and a contractor negotiate agreements (called forward pricing rate agreements)that cover labor and overhead rates for future contract proposals.suPSHIP/Bath and BIW had estab- lished a compositerate agreementcovering 3 years (1989 through 1991).BIW ’S proposal used the compositerate in computing its proposed price. According to the contract administrator, however, BIW should not have used the compositerate becausemany labor hours in the proposal had already beenincurred during 1988-a period not included in the compositerate. Rather, BIW should have used the actual lower rates in effect during 1988.

DCAA’s Post-Award Audit After the results of the review by the contract administrator, the Navy requestedthat DCAAperform a post-award defective pricing audit of this contract modification pursuant to Public Law 87-653,as amended.The law requires that, with certain exceptions,contractors submit cost or pricing data in support of proposedprices for noncompetitive contracts or modifications to enablethe contractual parties to negotiate a fair and reasonableprice to the government.Contractors certify that the data submitted is accurate, complete,and current. The law further requires that a clausebe included in the contract giving the governmentthe right to a price reduction if the contract price was overstated becausethe cer- tified data submitted was inaccurate, incomplete, or noncurrent. In its post-award report in March 1990,DCAA said that cost or pricing data submitted by BIW was not accurate, complete,or current as of the date of agreementon price. DCAAquestioned the use of the projected labor rates and recommendeda price reduction of about $546,000.

BIW representatives said that they disagreedwith the conclusions reachedby DCAAin its audit report. They said that BIW disclosedto the Navy that many labor hours were incurred during 1988.In addition, the contracting officer did not rely on the information becausethe negotia- tion was settled on a bottom-line basis.

In responseto the DGA audit, the Naval SeaSystems Command is responsiblefor initiating a price reduction under Public Law 87-663if the action is appropriate after reviewing the information. In April 1991, even though BIW disagreedwith the conclusionsin the audit report, BIW agreedto a voluntary reduction in the contract price of $383,874to reach an equitable settlement. BIW also agreedto pay interest of $37,691.

Page 31 GAO/NSIAD-91-86 Navy Shipbuilding Chapter 5 Issues Relating to tbe Destroyer Contract Modification

The restructuring agreementwas not supported by detailed cost and Contract pricing data. Instead BIW arguedthat its designof many of the sophisti- Restructuring cated features of the DDG-51,such as the reducedradar cross-section, entailed a laborious, “iterative” engineeringprocess that could not rea- sonably have beenanticipated at the time of the original contract and could not be readily quantified. The Navy, while recognizingthat this was an unusual modification, agreedwith BIW’Sposition and negotiated the restructuring with no detailed data on this portion.

Rationale for The Secretary of the Navy testified in January 1990that the Navy becameaware, 4 years after the contract award, that the effort required Restructu ring by the shipbuilder to achieve the Navy’s goal of reducing the ship’s radar cross-sectionwas clearly greater than the specific requirements of the original contract. The Secretary said the restructuring restored an equitable sharing of the risk betweenthe Navy and BIW in light of signif- icant changesin risk resulting from the increasedeffort neededto reducethe ship’s radar cross-section.

BIW representativescommented that the restructuring was necessary becausethey were awarded a fixed-price incentive type of contract. They said that it has becomewidely recognizedthat the use of a fixed- priced contract was not workable or compatible with the developmental nature of a highly complex warship. They said they had previously requestedthe Navy to restructure the contract to a cost-reimbursable contract, but that the Navy declined to do so.

In responseto a draft of our January 1990report, BIW stressedthat the restructuring was necessary“ to more appropriately share risks on a contract which both parties by 1989had cometo agreerequired restruc- turing.” BIW also pointed out that it provided additional considerationto the Navy in the form of liquidated damages,extended warranties, and the company’scommitment to maintain high manning levels on the lead ship until delivery. The contracting officer said that the Navy relied on the contents of a letter from the chairman of BIW to the Naval SeaSystems Command in July 1989 as the key documentin the Navy’s decisionto restructure the I contract. The letter discussed,in generalterms, that many aspectsof the Y lead ship designwere developmentaland broader in scopethan envi- sioned at the time of the original contract award. The developmental issuesincluded the radar cross-section,as well as several other systems, such as the collective protection system, which protects the crew from

Page 32 GAO/NSIAD-91-86 Navy Shipbuilding Chapter 5 Issues Rehdng to the Destroyer Contract Modification

contaminated air. BIW did not quantify the cost impact of the develop- mental issueseither separately or in total, and the letter said that the total impact on BIW’S work from these issuesmay never be fully known or quantified. Prior to awarding the contract modification, the Navy had legal con- cerns relating to the restructuring. BIW lacked data to establish the cost of the developmentaldesign work, which was the basis for the restruc- turing. Navy legal counselconcluded that the proposedrestructuring was highly unusual but that, under the circumstances,it was not improper, provided its ultimate impact was fully assessedand judged to be reasonable,The Naval SeaSystems Command then decidedthat the anticipated cost of the restructuring was fair and reasonable,and the contracting officer bound the governmentto a changedcontract arrangementby executing the modification.

Concerns Raised on The Naval SeaSystems Command performed a legal analysis of the pro- Adequacy of Support Prior posedcontract restructuring in August 1989 at the contracting officer’s request. According to the analysis, the submissionsby BIW had beenless to Modification than specific regarding the basis for requestingthe restructuring. The vaguenesswas attributable to a number of causes,including the difficul- ties created by the classified nature of the underlying subject matter (radar cross-section)and BIW’S generallaxity in generatingproposal support.

In the legal analysis, Navy counselpointed out, however, that BIW was entitled to an equitable adjustment under the contract, basically for changesthat related to radar-crosssection. The reasonswere that the contract requirements in that area were “very brief, very general,and very vague.” Thesefactors necessitatedthat BIW, accordingto the anal- ysis, perform significant additional work not initially contemplatedby the contracting parties to meet the Navy’s ultimate goal of reducing the radar cross-section. The legal analysis further pointed out that the Navy had a difficult time in quantifying the adjustment due BIW. BIW presentedno evidenceof an attempt to quantify the adjustment to which it believed it was entitled in the usual manner of identifying a specific increasein target cost, target profit, and ceiling price. Navy counselstated that, ordinarily, a contractor’s claim will fail if it cannot be quantified, since the contractor bears the burden of proof in showing not only entitlement to an adjust- ment, but also the amount of the adjustment. The analysis recognized,

Page 33 GAO/NSIAD-91-96 Navy Shipbuilding Chapter 5 Iames Relatiug to the Destroyer Contract Modification

however, that even though the exact amount cannot be shown, monies can be recoveredwhere the Navy’s liability and a basis for estimating the amount are proven. Navy counselconcluded in the analysis that the contract restructuring was highly unusual, but not improper, provided the ultimate impact was fully assessedand judged to be reasonable.*

Inadequate Support for the The Navy was responsibleto ensurethat the ultimate impact of the Navy’s Decision to restructuring was judged to be fair and reasonable.We have found no documentationto show how the Navy decidedthat the restructuring’s Restructure the Contract cost impact representeda reasonableprice for BIW’S work. According to the contracting officer, he attempted to obtain detailed information from BIW but was told that it was not available. The contracting officer also said that the Naval SeaSystems Command ’s representativesbelieved that BIW was entitled to the restructuring, and representatives of the Assistant Secretary of the Navy for Shipbuilding and Logistics agreedwith the entitlement. He told us that the basecon- tract and the intent of the contract were consideredin connectionwith reviewing BIW’S proposal. In addition, data existed within the Navy on these issues,such as an internal briefing paper on the radar cross- section prepared by the destroyer program office.

We cannot dispute, given the nature of the design and evaluation efforts, the fact that it might have beendifficult for BIW to be precise with respect to the additional work it performed and its cost. However, BIW at least should have furnished a basis for estimating the costs, and the Navy should have determined and documentedwhether the esti- mates supported BIW’S proposal. The Navy also did not document an analysis of the value of certain addi- tional items included in BIW’S proposal. Theseitems included (1) releasingthe Navy from liability under pre-existing claims, (2) foregoing contract adjustments on prior engineeringchange proposals, (3) extending the warranty of the lead ship, (4) completing design and con- struction within the current schedule,and (5) accepting a liquidated damagesclause for delays in the delivery of the lead ship. This offer was not directly related to the additional radar cross-sectionwork, but was proposedand acceptedas further consideration for the contract

‘The Navy counsel’sanalysis illustrates that a recognizedvehicle for convertinga fixed-pricecon- tract to a cost-reimbursablecontract is Public Law 86-804,which authorizesextraordinary contrac- tual relief to facilitate the nationaldefense. The statuterequires go-days notice to the Congress beforeusing the authority to obligatethe governmentto an amountover $25 million.

Page 34 GAO/NSIAD-91-86 Navy Shipbuildiug Chapter 6 Issues Relatiug to the Destroyer Contract Modification

modification. None of the documentationwe reviewed discussedthe validity and value of the pre-existing claims, the value of the contract adjustments, or the needfor and value of the extendedwarranty.

Concern Over Precedent In our January 1990report on the cost and scheduleproblems with the Established by the DDG-61program, we discussedour concernsthat the contract restruc- turing at Bath Iron Works could establish an inappropriate precedent Restructuring for shipbuilders having difficulty with fixed-price contracts. Near the conclusionof our current review in March 1991,the Navy negotiated a major contract modification with Ingalls Shipbuilding on the first follow ship in the destroyer program (DDG-52).The proposal for this modifica- tion had many similarities to the contract modification with Bath Iron Works and illustrates our concernsdiscussed in the January 1990 report. The Navy awarded Ingalls Shipbuilding a fixed-price incentive contract in May 1987at $162 million, mainly for the construction of the DDG-62. Ingalls’ proposal, submitted in November 1989,included (1) construc- tion aspectsof implementing radar cross-sectionrequirements, (2) delivery of late and deficient construction drawings (and revisions to drawings) to Ingalls by BIW on behalf of the Navy, and (3) changesin the ship’s capabilities for rearming helicopters. The problems that led to the proposal are the result of concurrent developmentand construction in the destroyer program. The proposal included, as one option, restructuring the contract by altering the sharing ratio and increasingthe contract ceiling price. We discussedour concernswith the proposal in a December1990 letter to the Secretary of Defense.The proposal was settled, without restruc- turing, in March 1991by increasingthe target price about $77.4 million and the ceiling price about $96.4 million, Theseamounts are large in relation to the original contract value of $162 million. Accordingly, as part of our ongoingwork on cost, schedule,and performance issuesin the destroyer program, we are currently reviewing the documentation supporting this modification.

As a result of the Navy and DCAAreview of the allegation that inaccu- Conclusions” rate cost data was submitted to support the current modification, BIW agreedto a voluntary price reduction of about $384,000.The more important issue, however, is the contract restructuring that increased Navy payments to BIW by about $37 million without detailed supporting

Page 35 GAO/NSIAD-91-96 Navy Shipbuilding Chapter I Isfmem R.eIadng to the Destroyer Contract Modification

data. Even though we recognizethe technical challengesBIW faced on this program, the Navy cannot determine whether the cost associated with the restructuring was fair and reasonable.The Navy should have required sufficient supporting data to ensurethat the negotiated arrangementswere equitable. An agreementbased on just the general concernspresented by BIW representswhat we consider a dangerous precedentfor other contractors experiencingsimilar difficulties. We believe the recent Ingalls proposal illustrates our concern.

Page 36 GAO/NSIAD-914% Navy Shipbuilding The Navy’s Review of the Allegations and Its Oversight of Contracts at BIW

Even though several million dollars will be returned to the government as a result of the Navy’s review, we believe the Navy’s actions were inadequate.In our opinion, the Navy should not have relied primarily on the local oversight office at Bath to conduct the review, and the Naval Inspector Generalshould have done a better job planning, documenting, and reporting the results of the review. Moreover,we believe a primary causeof the problemsthat the allega- tions disclosedwas ineffective Navy oversight of its contracts with BIW. For example, allegations of improper labor time chargeshad merit. Also, DCAAhas reported on deficienciesin BIW’Stime-charging system for sev- eral years, and the Navy has not required BIW to establish a better system. Other issues,such as the lack of documentationon ripout and rework on the cruiser program and the lack of adequatecost data to support the contract restructuring, illustrate that the Navy has not exer- cised effective stewardship over the government’sinterests.

In October 1989,the Director of Investigations for the Inspector General Inadequate Navy of the Naval SeaSystems Command referred the allegationsto Review of the suPsHIP/Bath,which was tasked to perform a review of each allegation. Allegations suPSHIP/Bathassigned experienced contract administrators to determine the validity of each allegation. It was responsiblefor the on-site review and requestedDCAA to assist in many areas.However, the Naval Inspector General,the focal point for receipt and tasking to Navy orga- nizations of Navy hotline allegations,subsequently assumed control of the review and assembleda team that performed several brief site visits to Bath during the review. Basedon the site visits and written reports from suPsHIP/Bathand DCAA, the Naval Inspector Generalissued two reports. The first report, issued in February 1990, provided extensive data on each of the allegations basedprimarily on work performed by suPsHrP/Bath.As part of the first report, the Naval Inspector Generaltasked DCAAto perform several additional audits in connectionwith the allegations.In the second report, issuedin May 1990, it presenteda brief status of the actions taken by the Navy in connectionwith the allegations.

Subsequentto the secondreport, DCAAissued a seriesof audit reports concerningimproper chargesin the cruiser and destroyer programs. suPsHIP/Bathand BIW participated with DCAAin conducting these audits. Thesereports were issuedperiodically up to February 1991 and covered

Page37 GAO/NSIAD91435 Navy Shipbuilding Chapter 0 The Navy’s Review of the Allegations and Ita Oversight of Contracts at BlW

improper chargesassociated with issuessuch as drawing revisions, revi- sion notices, and supervision.

During the courseof its work, DCAAreferred someconcerns on possible intentional mischargingto the Naval Investigative Service.In December 1990,the Naval Investigative Service concludedthat its work did not discloseany intentional mischarging. In April 1991,according to a representative of the Naval Inspector General,it was continuing to assessthe S1JPsHIP/Bathand IXAA reports and had not decidedon what action to take or whether to issue any additional reports.

Selection of SUPSHIP/Bath In our opinion, suPsHIP/Bathshould not have beenplaced in a position to to Review Allegations determinethe validity of the reported allegations becauseit is respon- sible for overseeingBIW performance under various contracts and nego- tiating contractual agreementswith BIW. Seriousquestions can be raised whether suPsHIP/Bathwas meeting its responsibilities if, as alleged,sig- nificant levels of improper chargeswere identified. Despite the intentional or potentially criminal nature of the activities cited in the allegations,SUPsHIP/Bath was tasked to review the allega- tions, although its personnelreviewing the allegationswere contract administrators, not investigators or auditors. Moreover, contrary to normal investigative practices, suPsHIP/Bathinformed BIW about the details of the allegations,and BIW becamea major participant in reviewing the allegations.Three months after SuPsHIP/Bathbegan its review, DCAAreferred certain matters to the Navy’s professional investi- gative unit, the Naval Investigative Service.

Other Deficiencies in the The Naval Inpsector Generalhad ultimate responsibility for the Navy’s Navy’s Review of the review of the allegations.We also found deficienciesrelating to the plan- ning, documenting,and reporting of its work. For example, as discussed Allegations in chapter 3, the Navy concluded,without adequatereview and docu- mentation, that the allegation on ripout and rework did not have merit. The Naval Inspector General’sfirst report of the investigation had major inaccuracies,and the two reports, in general,did not thoroughly address somekey areas.Although suPsHIP/Bathand DCAAhave since prepared reports for the Naval Inspector Generalon various limited segmentsof the allegations,they have not written a comprehensivereport on the

Page 38 GAO/NSLAD-91-85 Navy Shipbuilding Chapter 6 The Navy’s Review of the Allegations and Its Oversight of Contracts at BIW

Navy’s overall assessmentof the allegations,which includes findings, conclusions,and recommendations.Specifically, the Navy needsto docu- ment the extent of the problems, why the problems occurred, and what needsto be doneto prevent a recurrence. Several examplesof the deficienciesin the Naval Inspector General’s reports and supporting work follow. The Naval Inspector Generaldid not prepare a written investigative plan or audit program and had no working papers to support its work. The Naval Inspector Generalrepresentatives said they did not prepare working papers to avoid public disclosure of interim audit results via a Freedom-of-Information-Actrequest. They also stated that the reports serve as the working papers.

For example, the Naval Inspector General’sfirst report provides a dis- cussion of the contract modification that restructured the lead ship con- tract to increasethe Navy’s share of contract costs. The discussionin the report provides an example of the importance of working papers. The report said that unproven allegations fueled suspicion that the funding was not well supported in light of certain cost and contract information; however, the suspicions“ were allayed by facts available in the headquartersoffices of the Navy.” The Naval Inspector Generalrep resentative responsiblefor this statement is no longer employedby that office. Without a record of the facts gatheredat the meetings,there is no way to determine the basis for the position in the report. (Seechapter 6 for a discussionof the contract modification.)

The Naval Inspector General’sfirst report also contained many signifi- cant factual errors and misleading statements.For example,the report stated that, as part of its quality assuranceprogram, suPSHIP/Bathregu- larly reviews revision notices to determine whether labor mischarging has occurred. The report then stated that SUPSHIP reviewed revision notices on the DDG-61and found casesof mischarging;the amount of mischarging was then comparedwith amounts spent on revisions. The statements in the report were inaccurate. suPsHIP/Bath’programs has no provisions for determining whether improper charging has occurred. Also, the numbers were confusedwith the results of suPsHrP/Bath’s review of allegedimproper chargesin the cruiser program and were unrelated to any improper chargesin the destroyer program.

A suPsHIP/Groton(Connecticut) contract administrator, responsiblefor reviewing the allegation of ripout and rework in the cruiser program,

Page 39 GAO/NSIAD-91445 Navy Shipbuilding Chapter 6 The Navy’e Beview of the Allegations and Its Oversight of Contracta at BIW

said that the description of his review of ripout and rework in the first report was misleading.For example, contrary to implications in the report, he did not inspect repairs related to the revision notices under review; the ships were no longer physically located at the shipyard. Also, the contract administrator said that, basedon the confusing pres- entation of this data in the report, the Naval Inspector Generalrepresen- tative who prepared the report did not understand the information discussed.

Although DCAAhad previously reported its concernson BIW’S internal controls, the Naval Inspector Generaldid not include in its reports any major discussionof internal control weaknessesat BIW. However, in our opinion, the overriding issue concerningthe review of the allegations was the lack of adequatedata on contract charges.Thus, we believe that the Naval Inspector Generalcould not addressthe substanceof the alle- gations without addressingthe needfor better data on contract charges and better internal controls. The Naval Inspector Generaldid not adhereto Navy instructions for hotline investigations. Among other things, the instructions require that Navy personnelinvestigating these complaints meet standards for estab- lishing records that are sufficient to evaluate an investigation. Further, the instructions also require reports to be straightforward, logical, and accurate.

1\TnnA fnv Rnttn We believe many of the problems disclosedby the allegations could have lyccu IuI ucbbtir beenavoided by better Navy monitoring and oversight of contracts. The Controls and previous chapters discussingeach of the allegationspointed out Oversight at BIW numerousexamples of the needfor better oversight. . Contractual disputes on the cruiser program that took several years to resolve. Little progresswas being made on these issuesbefore receipt of the allegations. Resolutionof these issuesresulted in recovery of $2.2 million by the Navy (seech. 2). . Becauseof inadequatedocumentation of ripout and rework on the cruiser program, there is no way to be sure that the Navy was not chargedfor work that was never done(see ch. 3). . Costs were improperly chargedto a cost-reimbursablecontract rather than a fixed-price contract, and the true extent of such improper chargeswill never be known becauseof problems with the time charging system at BIW (see ch. 4).

Page 40 GAO/NSLAD-91-96 Navy Shipbuilding Chapter 6 The Navy’s Bevlew of the Allegations and Its Overnight of Contracts at BIW

. The cost and pricing data submitted for the technical part of the destroyer contract modification had problems, and the Navy approved the contract restructuring without adequatedocumentation (see ch. 6).

DCAA Concerns With BIW Besidesthe concernsstemming from the specific allegations,DCAA has Internal Controls for several years recommendedimprovements in internal controls over BIW’S time-charging system. After receiving the allegations,the Naval Inspector Generaltasked DCU to perform a comprehensivelabor audit aimed at determining the accu- racy and reliability of BIW’s labor cost accountingsystem. DCAA’S February 1990report indicated that the BIW system significantly lacked adequateinternal controls. According to government auditing standards, internal controls include a plan of organization and methods and proce- dures adoptedby managementto ensurethat (1) goals and objectives are,met, (2) resourcesare used consistent with laws, regulations, and policies, (3) resourcesare safeguardedagainst waste, loss, and misuse, and (4) reliable data are obtained, maintained, and fairly disclosedin reports.

In its discussionof inadequateinternal controls, DCXAreported that time-keepingprocedures provide little assurancethat labor costs were properly charged,and, as a result, it found several casesof mischarging. The DCAAreport pointed out that, although BIW corrects casesof mis- charging when identified, BIW has not corrected deficienciesin its labor- charging system. In December1990, the Navy and DCAArandomly selectedand inter- viewed BIW employeesto determinethe accuracy of their time records. They found 6 time-charging problems associatedwith 5 of 10 employees selectedfor review. The resulting February 1991report identified the following:

l one employeemischarged 8 hours to an improper contract; . a supervisor prepared and signedtime cards for two employeesbefore the employeescompleted their assignment; 9 superviors had not signedtime cards for two employeesfor the previous day; and . one employeedid not have a completedtime card for the previous day.

The DCAA report said that these types of discrepancieshave beenprevi- ously reported in past reviews. The report said that, becauseof the

Page 41 GAO/NSIAD-91-96 Navy Shipbuilding Chapter 0 The Navy’s Bevlew of the Allegationa and Its Overnight of Contracts at BIW

repetitive nature of the deficiencies,BIW representativesmust vigor- ously stress neededcorrective actions and reemphasizeadherence to policies and proceduresto strengthen their internal controls. The report also said that BIW representatives continuously fail to addressthe causes of these discrepanciesand only addressthe specific cases.

DCAAhas recommendedfor several years that the Navy not validate BIW’S cost and schedulecontrol system until improper time card charging proceduresfor production workers were rectified. According to DCAA representatives,supervisors completethe portion of the time card showing which jobs the direct labor employeesworked on. Also, the workers do not sign their time cards to show their approval of the chargesentered by their supervisors. Thus, DCAAbelieves that the direct labor hour chargescannot be verified and are subject to manipulation by supervisors who are also responsiblefor meeting labor hour budgets.

In December1989, DCAA recommended that 1.3 percent of BIW’S progress payments be withheld until BIW remediedthe time card problem. As of April 1991,although discussionsbetween the Navy, DCAA,and BIW were ongoing,time-charging practices for the production workers had not changed.

Conclusions and Even though the Navy’s review of the allegations resulted in the return of several million dollars from BIW, we believe its review was inadequate Recommendation and that the true extent of the problems will never be known. The Navy did not do a rigorous, independentreview, and in several areas limited data makes a thorough accountingimpossible. Moreover, the allegations highlighted what we believe is ineffective Navy oversight of its contracts at BIW. DCAAhas long recommended improvements in BIW’S time-charging system, but the Navy has not insti- tuted better controls. We recommendedin chapter 4 that the Navy work with BIW on those controls. In several other areas,more on-site moni- toring by the Navy could help ensurethat the government’sinterests are better protected. Therefore, we recommendthat the Secretary of the Navy review and strengthen oversight activities at BIW through measuressuch as increasedmonitoring, prompt attention to contract managementissues, and improvements in internal controls.

Page 42 GAO/NSIAD-91-86 Navy Shipbullding Page 43 GAO/NSW9186 Navy Shipbuilding Appendix I Major Contributors to This Report

Brad Hathaway, AssociateDirector National Security and Julius S. Brown, Assistant Director International Affairs Division, Washington, D.C.

Jerold D. Cohen,Assistant GeneralCounsel Office of the General Alan S. Goldberg,Senior Attorney Counsel

Richard Silveira, Navy IssuesArea Coordinator Boston RegionalOffice Jeffrey Rose,Regional Management Representative Kendall Graffam, Evaluator-in-Charge Robert Ballard, Evaluator Robert Krailo, Evaluator

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