Middle East Economic Survey

VOL. XLVII

No 40

4-October-2004

IRW Study Of Recent Audits Shows Iraqi Fund Mismanagement

Recent audits expose serious failures in American oversight of Iraq’s revenues and US reconstruction funds, said a report by the Open Society Institute’s Iraq Revenue Watch (IRW). The report, published in September and entitled Disorder, Negligence and Mismanagement: How the CPA Handled Iraq Reconstruction Funds, notes that audits released by the Coalition Provisional Authority Inspector General (CPA-IG), the International Advisory and Monitoring Board (IAMB) and Pentagon show that the CPA kept poor records and monitored contracts ineffectively. Furthermore contractors paid inadequate attention to controlling costs, and failed to apply standard US contracting practices when Iraqi funds were being disbursed.

 “The CPA did not do its job regarding the oversight of reconstruction funds,” said Svetlana Tsalik, director of the Revenue Watch project. “It failed to stop the misuse and waste of money that belonged to the Iraqi people and American taxpayers.” Furthermore, until recently there was no publicly available information about which companies were being paid with Iraqi oil revenues. This information was finally made available in an appendix released by the CPA-IG in August 2004 (see below).

An analysis of the data suggests that the CPA awarded US firms 74% of the value of the $1.5bn in contracts paid for with Iraqi funds and together US and UK companies received 85%. Iraqi firms, by contrast, received just 2% of the value. “Government favorites such as Kellogg, Brown and Root (KBR) benefited at the expense of Iraqi companies whose workers badly need jobs,” noted Ms Tsalik.

Contracts Awarded By US Government Agencies Paid For With Iraqi Funds

Source: CPA Inspector General 30 July 2004 Audit Report (Appendix J).

*  The CPA-IG removed the names of the Iraqi contractors to protect their security.

¹⁾  Vested Iraqi assets are cash and other property held in foreign countries belonging to Saddam’s family and other top Ba'th officials. They were frozen, in this case, by US officials.

²⁾  Seized assets are those taken by coalition forces in Iraq.

Halliburton Billing System Shows Deficiencies

KBR, the Halliburton subsidiary that Pentagon auditors started investigating in December 2003 (MEES, 23 August), received 60% of the value of all contracts paid with Iraqi funds. The report finds that KBR overcharged the US government for as much as $61mn for fuel imports into Iraq. A Pentagon audit in August of KBR’s billing system shows systematic deficiencies in the company’s accounting and billing procedures, incurring significant costs to US taxpayers and to Iraqi oil revenues, notes the IRW report. The company had billed the government $4.18bn to house and feed soldiers in the Middle East, but the Defense Contract Audit Agency (DCAA) recently disputed $1.8bn of that amount, claiming that the company failed to justify its costs.

Problems With Other Contracts

The investigators also found other contracts where costs could not be justified. Specifically, a contract for “national currency exchange” was approved for $31.7mn. A DCAA review found that the reported costs of labor far exceeded similar work previously done by this contractor, and that the contractor could not provide an independently verifiable explanation for the increase. Although the DCAA recommended cost reductions of over $5mn, the contract was nevertheless awarded at the contractor’s proposed price and no documentation existed of efforts to negotiate the price down.

In another example, Custer Battles, a nine-month-old company founded by two former army rangers, won a sub-contract from Washington Group International that was awarded by the Department of Defense. Tasked with providing 700 security guards, Custer Battles charged the Pentagon $20mn for six months of work. Yet its guards, hired by a Kurdish sub-contractor, received less than $200 per month, which totals $840,000 over six months. Consequently, adjusting for other overhead costs, the company pocketed roughly $19mn ‒ 95% of the contract value ‒ in profit. The Head of Contracting Activity took corrective action only during the audit, which was conducted between April and July 2004, notes IRW.

Poor Oversight

The CPA-IG found that “the CPA created policies and regulations which, although well-intended, did not establish effective control and accountability over $600mn in DFI funds held as cash available for disbursement.” The CPA-IG found that with regard to Iraqi cash assets, proper cash accountability was not maintained, physical security was inadequate, fund agent records were incomplete, and fund managers’ responsibilities were not assigned properly. The auditors were also unable to reconcile various financial statements for the DFI. The difficulty lay in part with the CPA’s decision to use cash basis accounting, which is more difficult to manage than accrual accounting. The auditors report that of the amount available for disbursement, as much as $50mn was cleared without proper receipts to validate payments. Overall, the investigators concluded that “While the CPA-IG did not identify any actual losses of cash, these were susceptible to fraud, waste, and abuse.”

Problems With CPA Control And Use Of Iraqi Oil Assets

A report released in July by the International Advisory and Monitoring Board (IAMB), the watchdog body set up by the UN, found numerous problems in the CPA’s control and use of Iraqi oil assets during the occupation (MEES, 7 July and 26 July). These include the absence of oil metering to control theft, poor record-keeping on oil sales, an absence of oversight of spending by the Iraqi ministries, the use of noncompetitive bidding procedures for some contracts, and the CPA’s refusal to transmit crucial information. The IAMB report was produced by consulting and auditing firm KPMG. While acknowledging the difficult post-conflict environment, the KPMG report notes that there were weaknesses in controls over oil extraction that allowed smuggling to take place in the months following the March-April 2003 conflict.

The IAMB is completing the second stage of its audit, examining the export sales of Iraqi petroleum and DFI operations for 1 January 2004 through to 28 June 2004, with results expected to be made public this month. A second audit of sole source contracts funded by the DFI has not yet been started, perhaps because of continued failure by the US to share information on these contracts, said IRW. On 8 September, the IAMB announced, “The special audit requested by the IAMB to determine the extent of sole-sourced contracts funded by the DFI has yet to be commissioned. Also, the IAMB has not received reports on audits undertaken by various US agencies on sole-sourced contracts, despite repeated requests. The IAMB expressed its strong concern with these delays that hamper fulfillment of its mandate.”

Negligent Handling Of Other Iraqi Assets

The CPA Inspector General also faulted the CPA for its management of cash and other property seized from the former regime during and after combat operations. Similarly, the auditors found poor record keeping of seized Iraqi cash coming from assets frozen abroad. The Program Review Board (PRB), a Coalition-dominated body, was responsible under the CPA for making recommendations to Ambassador Bremer on spending from the DFI, as well as seized and vested cash assets. The auditors examined 20 PRB requests for spending of seized and vested assets worth $120.1mn. Of this amount, no documentation existed in the files for $99.1mn of the spending, and inadequate documentation existed for a further $17.2mn. In all, “the validity and the purpose of disbursements for $116.3mn could not be determined.” Although by the conclusion of the audit the CPA comptroller’s personnel produced missing documentation, these shortcomings reflect a pattern throughout the CPA-IG’s audits, in which steps to correct financial negligence were taken only after auditors revealed it.

Post  CPA Dissolution

Following the dissolution of the CPA on 28 June, the Iraqi interim government took over the DFI. It collects all earnings from the sale of Iraq’s oil and gas and is now the primary funding source for the interim government’s operations and for the Iraqi national budget. Looking ahead, IRW notes that the Iraqi interim government appears to be following the poor example set by the CPA, making public next to no information about the DFI since the transfer of power. However, it appears that the Ministry of Finance is responsible for its management, said IRW.

Furthermore, although the CPA has been dissolved, the US will continue to oversee contracts paid for with Iraqi funds. The Iraqi Minister of Finance on 15 June designated authority to the Director of the Project and Contracting Office to administer contracts funded by the DFI and entered into before the CPA’s dissolution on 28 June. This transfer may explain why the CPA rushed to commit nearly all the savings that had accumulated in the DFI before the transfer (MEES, 2 August). Before its departure, the CPA also created three institutions to combat corruption and provide fiscal accountability: The Commission on Public Integrity (the criminal investigative arm which has not yet started operations), the Board of Supreme Audit, and the office of Inspector General.