Pentagon Parts Contractor Draws Bipartisan Outrage Over Pricing

Last February’s exposure of over-pricing by a sole-source defense contractor prompted bipartisan outrage among lawmakers that exploded into view on Wednesday.

The founder and chief executive of the TransDigm Group Inc. were grilled by members of the House Oversight and Reform Committee on their alleged $16 million in overcharging for military battlefield spare parts. The hearing also elicited a deputy secretary’s frustration with the company and showcased two officials from the Defense Department inspector general’s office whose earlier audit had reported excess profits on 46 of the 47 parts sold to the Pentagon.

The TransDigm case—monitored by Pentagon waste-watchers as a symptom of a larger problem of corporate overcharging—prompted Sen. Chuck Grassley, R-Iowa, on Wednesday to send an unusual hand-written note to acting Defense Secretary Patrick Shanahan demanding “accountability from DoD leadership.”

Grassley expressed concern about the process under which Defense contracting officers can collect cost data from contractors. He cited the IG’s February report, which showed that TransDigm’s 113 contracts from January 2015-2017 affected 47 parts coordinated by the Defense Logistics Agency. The IG—having obtained cost data not available to the DLA—calculated the company overcharged Uncle Sam by $16.1 million on a total of $29.7 million.

Assuming a reasonable profit of 15 percent, the actual profits in some cases were 1,200% on 17 of the parts, and in one case 4,436%. “These levels of profits are not consistent with the Federal Acquisition Regulation, Truth in Negotiations Act, and many other federal laws and regulations,” Grassley wrote. “The department must do a better job at screening contracts with those entities it chooses to do business with.”

Grassley told Shanahan that the reform recommendations to DLA and the Army from the IG—among them seeking a voluntary refund for the overcharges—“were a good start but ultimately insufficient” as corrective action. He then posed a series of questions on Defense’s ongoing work with TransDigm, with a deadline of June 13. He asked about the practice of seeking voluntary refunds, and the challenges in obtaining internal cost data from contractors.

The Office of the Defense Secretary did not respond to Government Executive requests for comment on Grassley’s letter by publication time.

On the other side of the Capitol, House Oversight members on the eve of their planned hearing received new documents apparently from whistleblowers inside TransDigm. The documents decribed TransDigm’s business model to acquire monopolies and hike prices using what the company called “value-based pricing,” which a former sales director for TransDigm told the committee “is code for raising prices.” The committee said the documents also describe how TransDigm and the Defense Department “purposely structured contracts to stay below the simplified acquisition threshold that would have required greater transparency and accountability for prices of materials purchased with taxpayers’ dollars.”

Rep. Ro Khanna, D-Calif., who chaired the hearing, said:  “We owe it to our service members to give them everything they need to fulfill their missions in the battlefield. What we will not tolerate are war profiteers—those who use the fact that we are at war to hold us hostage and hike their prices on mission-critical defense articles to astronomical levels because they know we have nowhere else to go.”

Several lawmakers asked the TransDigm executives to repay the Pentagon the $16 million. But the company leaders wouldn’t commit, saying that issue was part of an ongoing company review. CEO Kevin Stein said, "We follow all the rules and laws of the land." He argued that the inspector general had technically audited the DLA, not TransDigm, and found the company “did nothing in contravention of the federal acquisition laws and regulations with respect to its pricing.”

The executives said the IG “overstated the profits,” using “informal calculations that don’t accurately capture the cost of doing business,” which includes taxes, interest payments, litigation, acquisition and patents. “It has been wrongly asserted that TransDigm doesn’t develop any products itself, but only acquires businesses” and ups prices, Stein added. “On the contrary, we undertake significant engineering products,” with 3,000 engineers and a spend of almost $300 million last over the past five years.

Nicholas Howley, the company’s executive chairman and founder, stressed that TransDigm is a commercial enterprise with “other constituencies to think about—private shareholders, employees, management, commercial customers.” He acknowledged others’ “concern that we’ve done something wrong or illegal. But money is not the issue," he said. “We have to balance conflicting demands, different tensions.”

Principal Deputy IG Glenn Fine, accompanied by assistant IG Theresa Hull, who led the investigation, agreed that TransDigm should repay the money, though it is not required to, he noted. He also expressed concerns about sole-source suppliers. “When there is only one entity that can manufacture a part that is critical to the DoD, to the extent that this increases is problematic.”

Fine made other recommendations to Congress in his testimony, such as passing laws that require contracting officers to obtain contractor cost data before letting an award, and updating the FAR’s competition framework to crack down on single-source contracting for parts supplied by company subsidiaries.

TransDigm “was the only manufacturer at the time for three of the four parts competitively awarded, giving TransDigm the opportunity to set the market price for those parts because the other competitors planned to buy the parts from TransDigm before selling them to the DoD,” Fine testified. “We believe that, armed with these and other new statutory provisions, contracting officers would be better able to obtain crucial information necessary to level the playing field and award contracts for spare parts with these sole-source manufacturers that do not result in profits like those obtained by TransDigm and others.”

Kevin Fahey, assistant Defense secretary for acquisition, was critical of TransDigm, sometimes arguing directly with its representatives at the witness table. He said the company had “built its long-term business strategy on buying exclusive licenses or entire companies that manufacture military-unique, high-demand, low-value parts for DoD weapons systems and then drastically increasing the price of those parts." He added: “Is what TransDigm is doing illegal? No. Do I consider gouging our taxpayers for excessive costs immoral and unconscionable in the face of getting our warfighters what they need to fight? Yes.”

Solutions under way at Defense, Fahey added, include asking TransDigm for a voluntary refund, requesting changes in the Defense Federal Acquisition Regulation Supplement, and assigning the heads of Defense contracting activities to report to the principal director of Defense pricing and contracting every contractor that refuses to provide cost or pricing information. In addition, he said, the Defense Contract Management Agency’s Commercial Item Group will perform cost analyses for high-priority parts.

An observer of the hearing, Mandy Smithberger, director of the Straus Military Reform Project inside the nonprofit Project on Government Oversight, told Government Executive, “It's great to see bipartisan oversight and concern about the TransDigm overcharges, and particularly how Grassley continues to be a champion for taxpayers. Unfortunately, that IG report and a litany of others show that acquisition laws put the government at a significant disadvantage when it comes to these kinds of overcharges, and that recent changes Congress has made to increase thresholds are increasing the risks of waste, fraud, and abuse.”