Oversight & Out

Congressional mandates are making life difficult for federal contractors, and some could head for the door.

Determined to exercise their newfound oversight authority since assuming control in Congress 18 months ago, Democrats have increasingly turned their skeptical gaze on federal contracting. The $400-billion-per-year industry has been rattled by embarrassing public hearings, unnerved by a wave of new legislation and stymied by regulatory changes they view as unnecessarily burdensome. In recent months, independent auditors charged with rooting out waste, fraud and abuse have found a second home on Capitol Hill. Meanwhile, high-profile contractors such as Blackwater USA and KBR Inc. have learned that enemy fire comes in many forms.

It's impossible to argue that oversight of the contracting industry, which receives half the federal government's domestic discretionary budget, is not sorely needed. In the span of just a few weeks this spring, reports revealed that spending on Defense Department weapons systems had spiraled out of control and failed to deliver promised results; a 22-year-old contractor was caught selling decades-old munitions to Afghan security forces, and the Air Force was accused of improperly steering a $50 million contract to a company with close connections to senior department officers.

The increasingly inhospitable environment for contractors-the likes of which has not been seen since the 1980s-is causing some small and mid-size firms to reassess the cost of doing business with the government. Angela Styles, a partner in the law firm Crowell & Moring's government contracts division and a former administrator of federal procurement policy, says at least one of her clients has decided the risk now has trumped the potential rewards.

"You have good, solid companies . . . looking at the situation and saying, 'Gosh, the risk of doing something wrong, or being perceived as doing something wrong in government contracts, is so high that it's not just worth it for me to participate in this marketplace," Styles says. "They can see we are in an industry with low margins anyway and that it's difficult to manage if it's small products. It's tough to justify staying in."

The Breaking Point

Congress' dogged but occasionally paradoxical oversight of the federal contracting industry was encapsulated during a House Oversight and Government Reform Subcommittee hearing in mid-April.

The panel was investigating how a loophole had been inserted into a proposed change to the Federal Acquisition Regulation that would have exempted companies working overseas from new and tougher fraud reporting requirements. The Bush administration, barraged with negative publicity and under pressure from lawmakers and the Justice Department, assured the subcommittee that the exemption was a "drafting error" and that it was being closed through an expedited regulatory process. Incredulous committee members, who had waited weeks to grill administration officials about why they would not close the loophole, refused to take yes for an answer.

Noting the uncertainty about when the final rule would be published or implemented, Rep. Peter Welch, D-Vt., argued, "If we drop the pressure, the ball will be dropped." A week later, the House approved a Welch bill to close the loophole-despite the fact that the administration's acquiescence to the change had made such legislation moot.

At times, Congress' contract oversight has morphed into an extension of its angst with the Bush administration's privatization agenda, particularly in Iraq. But, political rhetoric and regulatory redundancy are just a few of the issues causing sleepless nights for the industry. Along with the proposed FAR change, which would require firms to self-report certain criminal procurement violations, industry experts cite legislation or a half dozen new rules that are causing firms to take a second look at their government contracting divisions.

"There's a lot of talk about where the breaking point is for companies," says Alan Chvotkin, executive vice president and counsel of the Professional Services Council, a contracting trade group. "There is a risk component to continuing to do business in this marketplace. There's also a cost side to compliance; it's not a free good."

Every time Congress or the administration approves a bolt-on system, Chvotkin says, the cost of complying with those changes is passed along to the government. And, while industry behemoths such as Lockheed Martin Corp. and Boeing Co. would have little difficulty complying with new regulations, there is greater concern for the mid-size firms that do not have a full-time compliance staff. These firms, which unlike their smaller counterparts are not exempt from some regulatory changes, could run the highest risk of running afoul of the rules.

"When you add on a lot of these elements that detract from the primary mission of the acquisition system, which is to provide goods and services to federal agencies to help them meet their mission . . . more companies are going to say, 'I can't afford to do business that way,' " Chvotkin says.

Some firms already have reached the breaking point. Lorraine Campos, a partner in the contracting division of the law firm Reed Smith, says her clients are beginning to assess the cost-benefit calculus of doing business with the government, and some are reaching the conclusion that it might be time to start heading for the exits. And if the economy improves-potentially boosting commercial business opportunities-more could be on the way, she says.

"I've certainly had clients that have said that with all these regulations and new requirements, the government is making it more difficult to do business with them," Campos says. "And they are beginning to question if they want to continue selling in the government contract sector. We have clients that have made decisions to not directly contract with the government."

Companies rarely follow through on such threats. Danielle Brian, executive director of the Project on Government Oversight, says contractors complained that the procurement reforms of the 1980s had created excessive red tape that would drive companies out the door for good. As it turns out, few ever left. "We've been hearing those threats for 20 years; that there's all these companies that will leave the sector," Brian says. "And it doesn't happen."

With profit margins still exceeding that of most commercial firms, government contractors are unlikely to find much sympathy among Democrats. "Under the Bush administration, federal spending on contracts skyrocketed, but contract management and oversight languished," Oversight Committee Chairman Henry Waxman, D-Calif., said in a statement. "The result was unprecedented levels of waste, fraud and abuse. It is essential that Congress take steps to increase transparency, accountability and efficiency to government contracting-both through legislation and increased oversight. We need more oversight to make sure that taxpayer dollars are spent wisely."

Welch added at the April loophole hearing: "There's some suggestion . . . that it's getting to be a hassle to do work with the government. But there are a lot of contractors that are doing just fine. We had Blackwater, who had done a billion [dollars'] worth of contracts and made 10 percent in profit, in here to testify. That's not a bad day."

But, veteran acquisition professionals argue that looking at a contractor's profit margin misses the point. "In terms of access to the market, the issue isn't with being able to access Blackwater," David Drabkin, the General Services Administration's acting chief acquisition officer, said at the same hearing. "It's being able to access the IT companies who don't do business with the government; who have solutions we'd like to buy, but who don't want to sell to us because of our terms and conditions and the fact that we've turned contracting into a criminal matter instead of a contractual business matter."

History shows that periods of increased procurement oversight occur practically every decade. In the 1990s it was Defense's spare parts scandal, in the 1980s it was Operation Ill Wind with military and defense contractors, and the 1970s focused on small business front companies. The difference this time, some experts say, is the amount of money at stake and the overall public perception of contractors. "It's really a feeling in the government that most government contractors are criminals," Styles says. "The word profit is bad, and they are all doing things to harm the government. That is the sense that a lot of people are getting."

Under the Gun

Increasing the discomfort for many firms is a pair of bills that passed in the House in late April. The first would require companies that receive more than $25 million in federal funds to disclose the salaries of their highest paid employees if government business accounts for 80 percent of their revenue. A second bill would create a public database of completed criminal, civil or administrative proceedings against contractors. A controversial provision that would have connected the database to suspension or debarment proceedings was scrapped after complaints from Rep. Tom Davis, R-Va.

The ranking member of the Oversight Committee, Davis says the bills were pushed by federal unions with an anti-outsourcing agenda and by Democrats looking to damage the Bush administration before the fall election. While Davis says his ability to stall the bills might have averted a potential contractor exodus, he still worries that the Demo-crats' oversight approach will handcuff the next administration in its attempts to reform government operations.

"Frankly, they don't know what they're talking about," says Davis, who will retire this year. "They don't have any history of government contracting. It is done by anecdote. It is done by reaction to press reports. And so you get these very inconsistent contracting policies and practices, and it's certainly not good."

Most agree that a wholesale shake-up of the contractor sector is un-likely, but some ripples already have begun. Late last year, Canon USA, EMC Corp. and Sun Microsystems all chose not to renew their GSA Schedule contracts because of increased scrutiny of their pricing policies from the agency's inspector general. And they're not the only ones leaving. GSA's Information Technology Schedule 70, the largest and most profitable of its Multiple Award Schedules, lost more than 250 companies last year, dropping from 5,149 in 2007 to 4,898 this year.

GSA officials did not provide a definitive reason for the decline, but they noted that Schedule 70 sales actually went up, in part because of growth in state and local markets.

As a matter of policy, many of the largest corporations, such as Microsoft and Apple, do not contract directly with the government. Some say they can set higher prices on the commercial side; others argue against creating a separate accounting system that requires them to keep two sets of books and subjects them to government auditors and regulations. The failure to attract such innovative firms, Davis says, is the real danger of overregulation and excessive oversight.

"The view of many of the members is that if they're not going to change, we're not going to give Microsoft a piece of the pie," he says. "Well, we ought to be looking for a piece of Microsoft's pie. It's this mentality that just doesn't understand the marketplace-that believes somehow if it moves you tax it, if it keeps moving you regulate it and if it stops moving you subsidize it; that government somehow by itself is determinative of outcomes. These regulations do nothing to improve efficiency, which is what we should be about."

With the tight rein of the GSA inspector general as the leading example, the auditing community as a whole is growing stronger and more authoritative. Reports from a host of IGs, the Government Accountability Office and the Defense Contracting Audit Agency are gaining far more attention than in the past. Even the suspension and debarment officials, all but ignored for many years, recently became front-page news with the Environmental Protection Agency's temporary suspension of IBM. Yet despite the increased scrutiny, contractor suspensions and debarments declined by 40 percent in 2007. Contracting critics say such figures show that industry oversight has been balanced and evenhanded.

"Congress is just fed up with hearing about the same problems and not receiving the answers and fixes needed to protect taxpayers, and now there has been a groundswell of that," says Scott Amey, POGO's general counsel. "Whether hearing from [nongovernment organizations] or reading it in newspapers; they are hearing from their constituents that the system lacks integrity, and they don't trust it. People are frustrated, and they want the system fixed."

The Root Cause

One of the few points industry representatives and public watchdogs can agree on is while Congress has done an admirable job of finding blatant examples of waste and misconduct, it has yet to tackle the root causes of government's procurement ailments. Since 2007, the House Oversight Committee has conducted two dozen hearings related to the contracting sector, while the Senate Homeland Security and Governmental Affairs Committee has hosted six. Just one hearing was focused on the acquisition workforce.

House hearings such as "Waste, Fraud and Abuse at the New U.S. Embassy in Iraq" and "Allegations of Misconduct at GSA" have provided more theater than some Hollywood blockbusters. Comparatively little attention has been paid to less-than-stimulating suggestions from the Acquisition Advisory Panel. The panel, made up of government and private sector acquisition specialists, issued 89 policy recommendations in 2007, including im-proving performance-based acquisition, providing better opportunities for small businesses and enforcing tighter controls on interagency contracts. A third of the recommendations could be implemented through legislation-the remaining through policy and regulatory changes-but as of yet, none has become law.

"There is no big-picture thinking, no vision anywhere to be seen," says Daniel Guttman, a professor at Johns Hopkins University and co-author of The Shadow Government (Pantheon Books, 1976), a history of government contracting. "Maybe vision is not possible, maybe muddling through will work, but this does not seem likely."

Top priorities for improving the procurement system remain in debate. Industry leaders see a need to beef up the acquisition workforce, which during the past decade has been cut in half. At the same time, contracting dollars more than doubled. The 2007 Defense appropriations bill, for example, included $48 million to boost the agency's auditing and oversight components, but did not direct funds to augment or train the contracting workforce. "It's not a sexy issue. It's a governance issue," Davis says. "There are no headlines to be had. But if you ask, what's the main thing we can do, it's: you get at the acquisition workforce and you pay them right and you train them right."

Watchdogs such as POGO, however, highlight the lack of competition with some large contracts, the use of time-and-materials contracts and inadequate pricing data. "We've done a decent job with holding hearings and pointing to the specific examples," Amey says. "But you need to ask why. Why did it happen, how did it happen, and how do we fix those problems."

When touting the benefits of oversight, lawmakers often quote U.S. Supreme Court Justice Louis Brandeis, who said, "Sunlight is the best disinfectant." Openness is crucial to fixing the ills of any pervasive problem-whether it's tainted drinking water or a dependence on sole-source contracts-but many say solutions and a long-term vision must quickly follow. If not, all the oversight in the world will be for naught.

"The governing reform premise that more competition, better management and transparency are sufficient has been demonstrably deficient for many years," Guttman says. "It is time for Congress and the executive [branch] to step back and look at the big picture of where the public service will go."