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as a class of purchaser by itself and/or its products a separate
class of products. Therefore, the supplier may pass through
increased costs to DOD and to no other class of customer. This
FEA method of permitting suppliers to recover cost increases
chargeable to special products" in sales of unprotected prod-
ucts does violence to cost and pricing concepts found in
ASPR and cost accounting standards. * * * The above
clearly demonstrated a conflict between the FEA price regu-
lations and the Armed Services Procurement Regulations.
* * * Therefore, DOD should be requested to obtain a modi-
fication of the FEA regulations or other appropriate action
to eliminate the disproportionate allocation of increased costs
to DOD.

RESULTS OF FEA AUDIT 1

On August 2, 1974; John Sawhill, Administrator of FEA, wrote a letter to Assistant Secretary of Defense Arthur I. Mendolia and said the FEA auditors "had observed" that the oil companies were not loading a disproportionate amount of cost pass-throughs onto military contracts. However, Mr. Sawhill's letter indicated that the auditors had not reached a conclusion on the matter but merely made an observation after checking in only "one instance" of pass-throughs on jet fuel. Mr. Sawhill's letter reads in part:

The observation on the part of the teams is that the companies are not loading a disproportionate amount of cost passthroughs on to military contracts. The two reasons cited are that prices are negotiated by DOD contracting officers, and that the companies want to retain the historical relationships

that the prices have had in the marketplace. On September 27, 1974, Mr. Sawhill of FEA wrote again to Mr. Mendolia and said FEA auditors had reviewed four additional con| tracts. He said that his review showed there was “no evidence to sug

gest that increased cost of crude petroleum are being passed through to the Department of Defense to any greater extent than to any other class of purchaser.”

The FEA responses to a request of this importance with millions of dollars at issue are not satisfactory. First, the FCA judgment is based on the auditors having checked in only a small number of instances of pass-throughs on jet fuel. Second, the safeguard pointed to by FEA to insure there were no excessive pass-throughs—that prices were negotiated by DFSC contracting officers---was a myth. As demonstrated earlier, no backup data was requested which would have determined excessive pass-throughs and “first offers” were accepted by contracting officers who had little experience in the area." Third, FEL's observa

*!- the 1974 DSA Audit report indicates, the contracting officer accepted the price of to contractor and would certify that his pricing was within the maximum allowable onder FE, regulations. The report said: "However, there was no requirement for the nrlar to specifically identify or reconstruct the legal product price. In instances where pertirement personnel endeavored to obtain legal price data, they were unsuccessful. Tuniors renerally res: onded by indicating that while ther did not furnish a specific ceiling prime, the prices submitted fell within the FDA guidelines. As a result, DFSC negotiators wild not establish whether prices were within the FEA legal price as they had not made nips Herold the contractor's negotiating personnel. As it matter of interest, it was noted that prires for identical products among lifferent contractors during approximately the same time frame, ranged from 20 cents to 47 cents per gallon" (p. 39).

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tion that the companies wanted "to retain the historical relationships that the prices have had in the marketplace” indicated again FEA's lack of knowledge of how DOD procurement was operating.

The ramifications of the failure of FEA to exercise its responsibilities on this pass-through question would be great: it probably cost the government millions of dollars on the petroleum purchases for the period July 1, 1973 through December 31, 1974 as will be shown in chapter VII.

# The Defense Supply Agency in a September 1974 report, commented on the FEA audit and said it was “not sufficiently detailed to fulfill DFSC's needs" (p. 39).

At the time the DSA voiced its criticism of the FEA audit, it recommended that DOD be given authority to conduct its own audits. In its September 1974 report, DSA said: "FEA informally has indicated that such delegation might be possible ; however, the question would have to be explored further before an official FEA determination could be made" (p. 39).

The Defense Department did not act on this DSA recommendation until December 6, 1974, when Martin Hoffman, General Counsel of DOD, wrote Robert E. Montgomery, Jr., General Counsel of FEA. Mr. Hoffman asked whether FEA could legally delegate to the Secretary of Defense its statutory audit authority.

The authority of DOD to conduct such audits was never granted. On December 10, 1974, DOD informally notified FEA that such audit authority was no longer desired.

7 Undoubtedly as a result of the Subcommittee investigation, FEÄ renewed its interest in the question.

On March 28, 1975, members of the Subcommittee staff interviewed Lon Smith of the Refining Audit and Review Program of FEA. Mr. Smith was asked about the details of the audit that was conducted by FEA pursuant to the DOD letter of May 25, 1974.

Mr. Smith admitted the issue whether the oil companies were loading a disproportionate amount of cost pass-throughs onto the military contracts had not been determined by the earlier audit. Mr. Smith said this matter had not been pursued further until two days earlier. March 26, 1974, when he personally prepared a "special directive" ordering a "special audit" be conducted and given top priority.

The special directive ordered "a comprehensive audit of jet fuel prices" be made of the following major oil companies : Atlantic Richfield, Continental Oil, Gulf, Exxon, Mobil, Texaco, Standard of California and Standard of Indiana.

The audit report was to include, among other things, “a summary of cost allocations and pricing procedures and conclusions on compliance with all phases of the pricing regulations with respect to jet fuel."

VI. NEGOTIATED PRICES FOR JULY-DECEMBER 1974 CONTRACTS AGAIN IGNORE COST AND PRICING DATA AND RELY ON TRADE PUBLICATIONS

MAY 1974 WAIVER REQUEST Despite continuing criticism that it was not obtaining enough backup data, DFSC requested in May 1974, from DSA, a blanket waiver of the requirement for contractors to submit cost or pricing data to support their prices for all purchases of petroleum products for the last six months of 1974.

On May 16, 1974, Admiral Oller, Commander of the DFSC, sent a memorandum to the DSA seeking a deviation from the requirements of ASPR relative to obtaining cost and pricing data and dispensing with the DD Form 633-7.

WAIVER REQUEST DENIED Both of these requests were denied by Dale R. Babione, Executive Director of Procurement and Production of the Defense Supply Agency, in a memorandum dated June 4, 1974 to the Commander, Defense Fuel Supply Center.

In his memorandum, Babione reiterated the criticism of using trade publications as the sole basis for supporting an exemption from the requirement to obtain certified cost or pricing data. He said:

4. Although prices quoted in certain petroleum news media, such as Platt's Oilgram and the Oil Buyers Guide, may be used as an indicator of these "market prices," we do not consider that prices reflected in such media represen market prices within the context of the ASPR and hence may not be used as a sole basis for an exemption from the requirement to obtain certified cost or pricing data. These reported prices represent an undetermined mix of quotes, offers, and actual sales prices, and do not reflect prices charged largevolume purchasers such as airlines and large retail chains, under long-term contracts. Also other unreported sales are made both above and below the published price ranges. A more reliable market price indicator will have to be found to justify a market price exemption (pp. 1–2).

WAIVER REQUEST RENEWED IN JUNE 1974 On June 14, 1974, Col. R. K. Estes, the Acting Commander of the Defense Fuel Supply Center, wrote another memorandum to the Defense Supply Agency and again requested permission to use various

petroleum trade journals as the basis for determining market prices in lieu of DD Form 633–7. Col. Estes said if this request was not granted, he wanted authority for a waiver of cost or pricing data as well as a waiver of the Cost Accounting Standards Clause disclosure statement for all negotiated petroleum contracts of $100,000 or more for delivery beginning July 1, 1974.

According to Estes there was insufficient time to secure DD Form 633-7 or cost or pricing data from the suppliers involved. He said:.

4. If DFSC's historical method of using market information cannot be used to substantiate exemption from cost or pricing data and the cost accounting standards, this Center will be unable to consummate contracts in excess of 72,000,000 barrels and one billion dollars of bulk petroleum products (excluding CONUS into-plane, bunkers and posts, camps and stations) for delivery beginning on 1 July 1974. Current domestic contracts for bulk petroleum products expire between 1-15 July 1974, and the majority of the contracts for the overseas petroleum requirements expire on 30 June 1974. DFSC cannot commence negotiations with domestic suppliers until they have been notified by FEA (probably 24 June) of their respective allocations to meet DOD's bulk purchase program for July-December 1974.

5. It is anticipated that many domestic small business firms who supply approximately 25 percent of the total domestic military jet fuel requirements will be unable to claim the exemption contemplated by the Form 633-7 because substantial sales to the general public of the same or similar products are not made by these small business firms. Thus, cost and pricing data will be required unless independent market information is used. Again, it is evident that contracts on this basis can

not be made within the necessary time frame (p. 2). Another reason given by Col. Estes for the waiver request was the prior refusal on the part of the petroleum companies to supply cost or pricing data or comply with cost accounting standards. Col. Estes said:

7. It is known the petroleum companies will resist any attempt by DOD to obtain cost or pricing data or compliance with cost accounting standards. Previous attempts have proved unsuccessful and company representatives state in conversations with DFSC personnel that they would refuse to furnish such data. The domestic companies feel that they are already furnishing ample data to the Government, including FEA and IRS audits, and that any additional data and andit would be unconscionable. FEA has informed this Center they are prohibited from sharing this type of data with other government agencies. Since the companies feel that they are being coerced into supplying the product, they are even less inclined to extend any special effort to supply DFSC with the required cost data (p. 3).

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TRADE PUBLICATION DATA USED IN JULY 1974 PURCHASES Despite the June 4, 1974 letter from DSA which said DFSC should no longer utilize trade publications as the sole basis for an exemption from the requirement to obtain certified cost or pricing data, their use was continued in July 1974 when the DoD petroleum purchases for the last six months of 1974 were made.

In June 1974 DFSC was faced with the problem of executing new contracts not only for jet fuel, but for the other petroleum products as the yearly contracts executed in March 1973 had now expired.

The DFSC had been instructed by its parent agency, DSA, that when it negotiated these contracts, it was required by law to obtain certified cost or pricing data from the contractors or, in lieu of that, documentation from the contractors or from independent sources to establish that the contractors prices were market prices being charged to other customers for substantial quantities of the product. The DSA specifically told the DFSC that data in trade publications such as Platt's Oilgram and the Oil Buyers Guide was not sufficient to establish a contractors price as a market price.

Nevertheless, DFSC proceeded in the summer of 1974 to place contracts amounting to almost $2 billion without complying with these instructions and without requiring the contractors to submit certified cost or pricing data or market data.

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