posted April 11, 2008 08:48 PM            

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Contractors may be saving the Army money. But fraud changes the equation

The U.S. Military has lost billions to fraud and mismanagement by private contractors in Iraq who do everything from cooking soldiers' meals to building hospitals to providing security. That raises a question: Does Pentagon outsourcing make sense?

"The presumption is that it is cheaper," says Jerrold T. Lundquist, director of the defense and aerospace practice at the consulting firm McKinsey & Co. Competitive bidding can keep the price of services down. Contractors are, in theory, more nimble at mobilizing and paring back their forces than a huge military bureaucracy. A recent study by the nonpartisan Congressional Budget Office concluded that in 2004 the U.S. reduced its costs by one-third for feeding and housing troops by paying one contractor to do the work -- a savings of nearly $3 billion. Such findings point to the conclusion that even with a lot of fraud and waste, outsourcing may still pay off.

But some experts on the topic aren't convinced. Because no one has an authoritative overall estimate of how much has been lost in Iraq to contractor deceit and incompetence, and many investigations are just getting under way, the financial harm could in the end outstrip any savings. There's also the intangible cost of taxpayers seeing their money wasted or stolen rather than spent to support troops risking their lives and dying. "What has happened in Iraq is just disgraceful," says Jeffrey H. Smith, a former Central Intelligence Agency general counsel during the Clinton Administration who now represents military contractors in private law practice.

Instances of military outsourcing gone bad in Iraq are now legion. For example, Parsons Global Services Inc. of Pasadena, Calif., lost its contract to build 150 health centers after it completed just six centers and collected $190 million -- $30 million over the project's budget. The U.S. Special Inspector General for Iraq Reconstruction is now reviewing all of Parsons' Iraq work. Officials at Parsons, which eventually completed an additional 13 centers, stand by their work, saying employees performed well under "extremely volatile conditions."

It's difficult to put an accurate price tag on contractor fraud in Iraq, however. The Government Accountability Office, the investigative arm of Congress, reported earlier this month that the Defense Dept. has recovered about $2 billion since 2001 from all outside contractors and government procurement officials accused of dishonesty or mismanagement, but the GAO didn't isolate those working in Iraq.

BILLIONS UNDER SCRUTINY
The losses to fraud and waste in Iraq are almost certainly in the billions, current and former government officials agree. The Special IG for Iraq Reconstruction says it has more than 80 open investigations and has referred 20 more cases to the Justice Dept. for prosecution. A spokesman for the criminal investigative arm of the Defense Dept. says that office expects a "rise in referrals of potential fraud or corruption cases" because of the recent deployment to Iraq of additional Pentagon investigators and FBI agents.

Democrats on the House Government Reform Committee have identified more than 50 "problem" contracts worth an estimated $21.3 billion that they say are under scrutiny by federal investigators. And that's just what has been publicly disclosed: Federal officials won't discuss other pending investigations because of secrecy insulating some of the contracts and most of the inquiries. All told, the Defense Dept. has spent more than $365 billion on the Iraq war and the global fight against terror since late 2002. Roughly $60 billion, or 16%, of the total has been paid to contractors for services, according to the Congressional Research Service.

The use of private companies and individuals to support the military began in earnest in the 1950s during the Korean War, when the Pentagon hired outside firms to help maintain helicopters. Outsourcing spread in the 1980s as the Reagan Administration sought to privatize government functions generally. The end of the Cold War inspired a broad push by the Clinton Administration to shrink the military and start closing unneeded bases. Those moves resulted in additional outsourcing of food, transportation, and other services.

Bipartisan legislation Congress passed in the 1990s reduced oversight of contractors in the name of increasing efficiency. But as the number of Pentagon contracting officials was trimmed by about 38% during this period, some contractors "exploited the new freedom," says Frank Camm, a senior economist for defense contracting at Rand Corp.

Other safeguards were lifted in the runup to the Iraq war. By law the Pentagon can circumvent competitive bidding rules in "emergency" situations such as war. The volume of sole-source and other noncompetitive contracts awarded by the military has soared 54% since 2000, from $65 billion to $100 billion.

Bush critics say the absence of competition invites waste and corruption. "The flawed contract approach has greatly contributed to the problems," says California Representative Henry A. Waxman, ranking Democrat on the Government Reform panel. "Instead of competition, the Administration has awarded monopoly cost-plus contracts to favored contractors like Halliburton (HAL )."

But the situation isn't clear-cut. Since the American invasion of Iraq in 2003, skeptics have questioned Halliburton's role in the war, emphasizing that before becoming Vice-President, Dick Cheney headed the Houston company. The Army confirmed earlier this month that it was ending a multibillion-dollar, 10-year contract held by Halliburton subsidiary Kellogg, Brown & Root to provide food, water, shelter, and other basic services to troops. The Pentagon, which has paid KBR $15 billion since 2001, plans to divide the work among four contractors, with KBR permitted to bid for a portion of it. Earlier, Defense Dept. auditors had labeled $1.2 billion in KBR charges as "excessive," "duplicative," or otherwise questionable. KBR officials say its costs were reasonable considering that the work was done under "extraordinarily hostile conditions." KBR also says it has resolved most of the audit disputes with the Army.

KBR's contentions received implicit support from a CBO study issued in October, 2005. The Capitol Hill budget agency examined KBR's work in Iraq during a 12-month period ending in mid-2004. To perform the tasks KBR completed, the U.S. Army would have had to recruit 41,000 additional troops and spend $8.2 billion, or $2.8 billion more than KBR's costs, the CBO found. Over time, the Pentagon would save billions more by employing KBR, the study projected.

Whether the government is able to take full advantage of such cost savings depends largely on whether it can rein in contract abuse. Authorities on military contracting say there are obvious steps the Pentagon can take: It could bolster the ranks of procurement staff and institute tougher procedures for awarding and reviewing contracts. But apart from the scrutiny of the large KBR contract, the Pentagon has no plans to make those moves. In fact, the military expects to further reduce its procurement oversight corps.

posted April 11, 2008 08:52 PM            

Almost since the first American tank rolled into Iraq last year, the role of private military contractors has been controversial. When Kellogg Brown & Root Inc. (KBR), a subsidiary of Halliburton Co. (HAC ), billed the government hundreds of millions of dollars to support the invasion, critics griped that it was receiving preferential treatment because of ties to the Bush Administration -- and was overcharging to boot. When the bodies of four security guards employed by Blackwater USA were mutilated in Fallujah in March while escorting food deliveries to U.S. troops, Marines laid siege to the city, igniting widespread violence. And when a classified U.S. military report came to light in late April alleging abuses of detainees at the Abu Ghraib prison, private military contractors (PMCS) found themselves in the center of a firestorm.

The end of the Cold War and Pentagon efforts to increase efficiency, speed the delivery of services, and free troops for purely military missions have triggered a boom in the outsourcing of work to private contractors. Indeed, with the strength of America's armed forces down 29%, to 1.5 million, since 1991, contractors have become a permanent part of the military machine, doing everything from providing food services to guarding Iraq Administrator L. Paul Bremer.

Now, along with the heady growth, come mounting concerns that an industry dependent on taxpayer dollars has been spiraling out of control. That has Congress, the Defense Dept., and the Coalition Provisional Authority (CPA) in Iraq scrambling to draft regulations that make contractors -- both on the security and services/reconstruction side of the industry -- more accountable.

Like many businesses that have to staff up rapidly, some security contractors have cut corners in the rush to expand. On the ground in Iraq, contractors appear to have operated with little or no supervision. Mercenaries are not choirboys, but some outfits have signed up hired guns trained by repressive regimes. And revelations that civilians are performing sensitive tasks such as interrogation have jolted Congress and the public. "This outsourcing thing has gone crazy," says Gary D. Solis, a former Marine Corps judge advocate and now adjunct law professor at Georgetown University. "You have a lot of people with heavy weaponry answerable to no one."

TAKING A PLEDGE. Contractor problems are not confined to the headline-making security and interrogation side of the business. The CPA's new inspector general, Stuart W. Bowen, is currently auditing five of the biggest contractors in Iraq -- Fluor (FLR ), Parsons, Washington Group International, Perini (PCR ), and KBR --to make sure they are following U.S. laws and codes of ethics, BusinessWeek has learned. "Our intent is to deter waste, fraud, and abuse and ensure compliance with federal law," Bowen said in a phone call from Baghdad.

There is no single industry association for contractors, but one group, International Peace Operations Assn. in Rosslyn, Va., is trying to bring some order to the security outfits. Members of the IPOA must pledge to follow a code of conduct and "strictly adhere to all relevant international laws and protocols on human rights." The IPOA currently has just nine members, including ArmorGroup International Inc., a British security firm with 900 employees in Iraq. But, says IPOA President Doug Brooks, "companies are starting to come together and realize the value of having an organization that sets standards."

BIG, BUT HOW BIG? Although many PMCs agree that the industry would benefit from increased oversight, some say Uncle Sam's proposals may go too far. Blackwater USA, based in Moyock, N.C., which has been criticized for employing former Chilean commandos trained during the dictatorship of Augusto Pinochet, takes issue with a Defense Dept. proposal to apply the Uniform Code of Military Justice to contractors. But, says Blackwater spokesman Chris Bertelli, "we have no problem with industry standards for hiring practices."

The exact size of the PMC business is difficult to determine because there is no central register of contracts, and the Defense Dept. sometimes has other agencies do its purchasing. For example, the contract with CACI International Inc. (CAI ) at Abu Ghraib prison was administered by the Interior Dept., according to The Washington Post. Still, P.W. Singer, a fellow at the Brookings Institution and author of Corporate Warriors: The Rise of the Privatized Military Industry, estimates it is a $100 billion industry with several hundred companies operating in more than 100 countries.

In a May 4 letter to the House Armed Services Committee, Defense Secretary Donald H. Rumsfeld said that approximately 20,000 private security workers are employed in Iraq. That doesn't include the thousands of civilians reconstructing bridges, roads, and phone lines. In the Gulf War, the military outsourced only 1% of its work, primarily for airfield maintenance. Singer estimates that contractors are handling as much as 30% of the military's services -- including reconstruction -- in Iraq. "We have pushed outsourcing way beyond what anyone contemplated," he says.

Spying a growth business, some big defense contractors are scooping up PMCs, many of which -- especially in the security sector -- are small and privately held. Computer Sciences (CSC ) acquired DynCorp, Northrop Grumman (NOC ) bought Vinnell, and L-3 Communications nabbed Military Professional Resources Inc. "[Defense giants] have been buying up these companies like mad," says Deborah D. Avant, a professor at George Washington University who is writing a book about military contractors. "This is where they think the future is."

Yet in the wake of Abu Ghraib, critics, including current and former military officials, are starting to ask some hard questions: Has the military pushed outsourcing too far too fast? Where do you draw the line? And who's in charge? A June, 2003, report by the General Accounting Office concluded that there are no Defense Dept.-wide policies "on the use of contractors to support deployed forces," a situation that sows confusion.

Few analysts see a fundamental problem with contractors building base camps, serving food, and cleaning toilets -- the logistical side of making war. The growing concern is about using contractors to perform functions such as security and interrogation. A report by Major General Antonio M. Taguba concluded that two interrogators-for-hire, one from CACI and one from Titan Corp. (TTN ), in conjunction with military officers, "were either directly or indirectly responsible for the abuses at Abu Ghraib." Titan says the individual worked for a subcontractor.

"Why the hell were contractors there in the first place?" asks John D. Hutson, a former Rear Admiral and Navy judge advocate general who is now dean of the Franklin Pierce Law Center. "I have a problem with people carrying weapons in an offensive way. And I have a serious problem with people in sensitive positions, like interrogators."

Blindsided by the Abu Ghraib scandal and allegations that PMCs have hired questionable employees, Congress is putting the Pentagon on notice to get a grip on mercenaries and even more benign contractors. House and Senate bills would require Defense to provide Congress with a plan for collecting data on contractors and clarifying the responsibilities of commanders who manage them. This Wild West of a business is not going to go away, but it could get a lot tamer fast.