U. S. Department of Agriculture Office of Inspector ... · 01001-3-Ch SEPTEMBER 1998 ` U. S. Department of Agriculture Office of Inspector General Audit Report National Fluid Milk

Audit Report No.01001-3-Ch SEPTEMBER 1998

`

U. S. Department of Agriculture

Office of Inspector General

Audit Report

National Fluid Milk ProcessorPromotion Program

NOTICE - THIS REPORT RESTRICTED TO OFFICIAL USE

This report is provided to program officials soley for theirofficial use. Further distribution of this information is notauthorized.

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TABLE OF CONTENTS

CHAPTER 1 - EXECUTIVE SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iv

Results in Brief . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iv

Key Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vi

Agency Position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vi

OIG Position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vii

CHAPTER 2 - INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Results of Management Alert . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Scope . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

CHAPTER 3 - FINDING NO. 1 - AMS AND THE FLUID MILK BOARD NEED TO STRENGTHEN THEIR CONTROL OF THE PROGRAM . . . 9

Recommendation No. 1a . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Recommendation No. 1b . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

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TABLE OF CONTENTS

CHAPTER 4 - CONTRACT PROCEDURES DID NOT COMPLY WITH REQUIREMENTS OF THE ACT

AND/OR ORDER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

FINDING NO. 2 - THE BOARD MADE CONTRACT PAYMENTS THAT WERE NOT APPROVED BY AMS . . . . . . . . . . . . . . . . . 21



FINDING NO. 3 - CONTRACTS DID NOT INCLUDE CERTAIN REQUIRED LANGUAGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25



FINDING NO. 4 - PROGRESS REPORTS WERE NOT SUBMITTED AND EXPENSE LIMITS WERE EXCEEDED . . . . 30



FINDING NO. 5 - CONTRACT TERMS WERE NOT BEING MET . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Recommendation No. 5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

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TABLE OF CONTENTS

FINDING NO. 6 - THE BOARD USED SOLE-SOURCE CONTRACTORS WITH NO EVIDENCE OF OTHER CONTRACTORS BEING CONSIDERED . . . . . . . . . . . . . . . . . . 34

Recommendation No. 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

FINDING NO. 7 - FINANCIAL STATEMENTS WERE INCORRECT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38



Recommendation No. 7c . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

EXHIBITS

A - AMS’ RESPONSE TO THE DRAFT REPORT . . . . . . . . . . . . . . . . . 44

B - OIG’S COMMENTS RELATED TO AMS’ WRITTEN RESPONSE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

C - ADVERTISING AGENCY’S MEMORANDUM TO OIG . . . . . . . . . . 72

D - ADVERTISING AGENCY’S MEMORANDUM TO OIG AS SENT BY AMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

E - ADVERTISING AGENCY’S MEMORANDUM TO ITS SUBSIDIARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

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CHAPTER 1 - EXECUTIVE SUMMARY

Results In Brief This report presents the results of our audit of the

Our review disclosed that the Board’s controls over

Agricultural Marketing Service’s (AMS) National FluidMilk Processor Promotion Program (Program). AMSrequested an audit of this new Program to ensure thatit was being administered in compliance with the FluidMilk Promotion Act of 1990 (Act) and the Fluid MilkOrder (Order).

Our review disclosed serious problems with theNational Fluid Milk Processor Promotion Board’s(Board) management structure and with the manner inwhich expenditures were made. The Board remaineddetached from the day-to-day operations of theProgram, delegating all administrative tasks tocontractors and taking no independent actions toascertain the effectiveness of the Program. Accordingto the Board Administrator (Person A), he did notbelieve anyone was interested in knowing whether theBoard’s activities influenced milk consumption.Concurrently, AMS provided little active oversight ofthe Board’s activities.

contracts were inadequate or were not working. TheBoard entered into sole-source contracts without anycompetition to ensure the most cost-effectiveprocurement and without obtaining AMS’ approvalprior to the effective date of the contracts. Theadministrative reports required by contracts, such asmonthly progress and performance reports and overallproject evaluation reports, were not being delivered,leaving the Board in a weakened position to managethe contracts. Payments were made which exceededcontract limits. These overpayments indicated that the

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internal controls were either inadequate or were notworking. In addition, the terms of contracts were notbeing enforced. One contract requires that a reserveof approximately $350,000 be established (to be paidas an incentive bonus if fluid milk sales increased) andmaintained; that reserve has not been established.

We identified payments made for 108 contracts;however, neither AMS nor the Board could provide uswith copies of 37 of these contracts. (We found noevidence to cause us to question the existence of the37 contracts as we found documentation in the filesthat indicated funds appeared to be expended forprogram-related purposes.) As a result, we could notascertain if funds spent for these goods/services metcontract specifications. Of the 71 contracts availablefor review, 33 were not signed by at least one of thecontracting parties prior to the contracts’ effectivedates. Also, AMS had not approved 68 of these71 contracts prior to the contracts’ effective dates.

The Board presented audited financial statementswhich did not accurately reflect its financial condition.The financial statements as of March 31, 1995, and asof April 30, 1996, contained material omissions andquestionable statements that, in the aggregate, weresignificant enough to affect the decisions of its users.

Because of the magnitude of the problems weidentified at the outset of our audit, we issued aManagement Alert on May 6, 1997. In theManagement Alert, we raised concerns dealing withthe very limited amount of AMS oversight of Boardactivities. We were also particularly concerned withthe Board’s control structure, its reliance oncontractors to run day-to-day operations, and itscontracting procedures, including ownership ofcopyrights developed with assessments collected asa result of the Act.

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Key We recommend that AMS suspend the operations ofRecommendations the Board until AMS and the Board jointly restructure

Agency Position AMS did not agree to suspend the Board’s activities.

In response to our Management Alert, AMS advisedthat it had taken a number of corrective actions.These actions included personnel changes to ensurebetter AMS oversight, the approval of a new contractreview process, the request for and receipt of anopinion from the Office of the General Counselconcerning the ownership of property developed withassessment funds, and continuing to review allminutes kept of Board meetings. We were alsoadvised that the Board has taken a number of actionsto strengthen control over the Program by increasingthe amount of time required of its Administrator froman average of 9 hours per week to 23 hours per week,establishing a new contract review procedure withAMS, and retaining outside legal counsel to aid incontract review and taking minutes of Board meetings.

While we acknowledge that certain changes havebeen made, we continue to have serious concernsover the management structure of the Board andcontracting procedures.

the management of Board activities to ensure fullcompliance with the Act and the Order. The Boardneeds to establish guidelines for awarding contractsand subcontracts to ensure that goods and servicesare not sole-sourced. In addition, we recommendedthat AMS continue to increase its oversight of Boardactivities.

Although AMS has made proposals to restructure themanagement of the Board’s activities, there have beenno definitive plans presented to date. AMS agreedwith most of the recommendations, though in somecases they proposed alternative actions or did not givesufficient details of the corrective actions they were

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OIG Position AMS should suspend the Board’s activities until AMS

proposing. AMS’s response is included as exhibit A.The AMS response included voluminous attachmentswhich are not included herein.

and the Board develop a plan to restructure themanagement of Board activities. Many of thecorrective actions proposed by AMS did notadequately address the audit recommendations. Wedo not agree with many of the comments made inAMS’ response to our draft report. (See exhibit B forassertions made by AMS and our response).

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CHAPTER 2 - INTRODUCTION

Background

The Agricultural Marketing Service (AMS) hasresponsibility for the National Fluid Milk ProcessorPromotion Program (Program), which was authorized bythe Fluid Milk Promotion Act of 1990 (Act) (Public Law101-624) and the Fluid Milk Promotion Amendments Actof 1993 (Public Law 103-72). The Program is designedto fund promotion, research, and consumer education.The Act directed the Secretary of Agriculture (Secretary)to issue a Fluid Milk Order (Order) to implement theProgram. The Order became effective onDecember 10, 1993, and the Secretary appointed thefirst National Fluid Milk Processor Promotion Board(Board) on June 6, 1994.

The Program is funded by a mandatory 20-cents-per-hundredweight assessment on all fluid milk productsprocessed and marketed commercially in consumer-type packages in the 48 contiguous United States andin the District of Columbia. The Act defines a fluid milkprocessor as “* * * any person who processes andmarkets commercially more than 500,000 pounds offluid milk products in consumer-type packages permonth.”

AMS’ oversight responsibilities include reviewing andapproving the Board’s budgets, contracts, advertisingcampaigns, and investment plans. AMS is alsoresponsible for evaluating the Program’s effectivenessand for ensuring that promotion funds are collected andspent consistent with the enabling legislation.


Assessment revenues from approximately370 processors totaled $168,729,598 fromDecember 10, 1993, through June 30, 1997. We foundno problems in the system of collecting and depositingassessments. Program expenses during that periodwere $131,225,781, and Board expenses were$288,329. (The Order required the Board to return$16,446,385 to the California Fluid Milk ProcessorPromotion Board. For this audit, we verified only thatthe funds were transferred to the California Fluid MilkProcessor Promotion Board. We did not review the useof these funds.)

The Board has a contract with the Milk IndustryFoundation (MIF) to perform various management andadministrative services. Because MIF does not haveemployees to perform these services, it contracts forthem with the International Dairy Foods Association(IDFA), its parent organization. (The chief executiveofficer, Person B, of both MIF and IDFA is a registeredlobbyist with the U.S. Congress.) MIF alsosubcontracts most of the advertising and public relationsactivities.

The Board’s contract with MIF requires MIF to conductpromotion and research activities and to provideadministrative services for the Milk Processor EducationProgram. The administrative services are to includeplanning and coordinating Board meetings andproviding onsite support personnel for Board andcommittee meetings. The MIF contract with IDFArequires IDFA to perform all tasks detailed in thecontract between the Board and MIF.

The Board also has two contracts with the certifiedpublic accounting (CPA) firm in which Person A, theBoard Administrator, is a principal. One contract is foroverseeing the collection of assessments and


performing accounting services; the other is forcontractor compliance reviews.

In addition, the Board has a contract with Person A, asan individual, to perform services as a part-timeadministrator for the Board. Finally, the Board also hasa contract with a law firm for legal services.

The Board contracted with MIF to use MIF resources topay bills on a reimbursable basis. This procedurechanged in 1995, when advertising expenses becametoo great. At that point, MIF decided it would onlyreview and approve expenses and submit them throughPerson A’s CPA firm to the Board for payment. Theprocedure changed again in 1997, at which point theadvertising agency began sending its invoices directlyto the CPA firm, while submitting duplicates to MIF forapproval.

The highly recognized milk-mustache advertisingcampaign has been the Board's primary method ofpromoting milk since the Board's inception. Althoughthese advertisements are highly recognized in themarketplace, the Board has not determined whether theadvertising campaign has resulted in increased milkconsumption.

We reviewed the Board’s activities in 1994 because ofcongressional concerns about the propriety of theBoard's dealings with a lobbying organization. Concerncentered around (1) the propriety of IDFA’s having anexecutive director for the Board before the Board itselfhad been sworn in and seated, and (2) the payment ofProgram funds to organizations (IDFA and MIF) whosechief executive officer and vice presidents wereregistered as lobbyists with the U.S. Congress. The useof Board funds for lobbying purposes is a violation ofthe Act.


We concluded that the Board had not prematurely hiredan executive director and that no Program funds hadbeen expended for lobbying purposes. We alsoconcluded that a combination of the Board’s hiring orcontracting for staff, the Board’s use of independentaudits, and AMS’ normal control structure of reviewingand approving Board-recommended activities shouldhave provided reasonable control measures to ensurethat promotion funds were used only for lawfulpurposes. However, during this audit we found thatthese measures were not properly taken. We foundproblems with the Board’s management structure,independent audits, and AMS’ oversight.

Results Of Management Alert

Our survey (01001-1-Ch) noted that the controlsoriginally intended to be implemented by the Boardwere either not implemented or not implemented asplanned. As a result, we issued a Management Alert,dated May 6, 1997, in which we recommended the AMSAdministrator take corrective actions. - We recommended that the AMS Administrator

require the Board to take full control of day-to-dayoperations for all Program activities. AMSresponded that by May 30, 1997, it would (1)send a letter to the Board outlining AMS’ positionregarding the Board’s responsibilities, and (2)work with the Board to develop a staff andstructure to take full control of operations. AMSasked the Board to consider hiring a full-timeadministrator and support personnel.

- We recommended that the AMS Administratorrequire that all contracts, subcontracts, andagreements that commit Program funds be timelyapproved. AMS responded that it would (1)direct the Board to stop paying for work that AMS


had not approved, (2) require that the Boardsubmit all contracts and subcontracts to AMS forreview, and (3) reevaluate its policy on reviewingand approving contracts and subcontracts within90 days.

- We recommended that title to all productsacquired with Program funds become theproperty of the Board. AMS responded that itwould obtain an opinion from the Office of theGeneral Counsel (OGC). (See page 28.)

In response to our Management Alert, the Boardincreased the Board Administrator’s responsibilities andcontracted for outside legal counsel; we continue tobelieve that more involvement by the Board and itsAdministrator is necessary. Most of the Board’sexpenditures (advertising expenses) are still beingmanaged by subcontractor personnel without activeinvolvement or oversight by the Board and with onlylimited oversight by its Administrator. AMS initiallyagreed to have all contracts, subcontracts, andagreements submitted for review prior to their effectivedates. However, AMS subsequently reached anagreement with the Board that only nine contracts wouldbe submitted for approval; all remaining contracts,subcontracts, and agreements would be kept on file atthe Board Administrator’s office for AMS’ review. Wedo not concur with this agreement between AMS andthe Board; AMS should, on a timely basis, receive allcontracts, subcontracts, and agreements for review.Finally, the Board has revised the language in asubcontract with a photographer for the Board to obtaintitle to the assets produced. However, under therevised language in the subcontract, the subcontractorwill retain physical possession and be paid a royalty forany use other than the original contract period. In form,it appears that the Board has obtained title to the


assets; in substance, the subcontractor still retains allsubstantive property rights.

Although we have not verified them, we were recentlyadvised of the following corrective actions taken byAMS and the Board.

S MIF is now submitting progress reports to theBoard.

S Certain unspecified changes have been made inthe Board’s meeting procedures and the Boardnow meets privately with its Administrator andlegal counsel during each Board meeting.

S Outside legal counsel (Person C) is to overseecontract development and compliance bycontractors with contract provisions.

S The Board changed the way its meeting minuteswere to be taken, prepared, and maintained.

S The Board developed a checklist of provisionsrequired for contracts and agreements.

S New procedures have been implemented toassure that celebrities sign agreements prior totheir photographs being taken.

Objectives

Our objectives were to: (1) Evaluate AMS’ proceduresfor overseeing the Program, including actions toaddress deficiencies identified in the OIG ManagementAlert dated May 6, 1997; (2) evaluate the Board’spolicies and procedures for administering the Programand assess whether internal controls were adequate toensure funds were used only for authorized purposes;(3) evaluate the contractors’ performance of their


responsibilities to the Board; and (4) evaluate theeffectiveness of the independent CPA firm’sperformance of its responsibilities to the Board.

Scope

The audit covered the Program from its inception inDecember 1993 through June 30, 1997. We reviewedand tested a judgmental sample of transactions,documents, and other records relating to assessmentstotaling $168 million and the associated expendituresand investments. We compared AMS’ reported milkproduction with the assessments and found them to bereasonable. We evaluated AMS’ procedures foroverseeing the Program, the Board’s policies andprocedures for administering the Program, selectedcontractors’ compliance with contractualresponsibilities, and the Board’s independent auditor’sresponsibility to the Board. We identified internalcontrols through interviews and tested theireffectiveness. Audit work was performed at AMSHeadquarters in Washington, D.C.; the BoardAdministrator’s office in Bethesda, Maryland; theBoard’s major contractors in Washington, D.C., andBethesda, Maryland; the advertising agency’s offices inChicago, Illinois, and New York, New York; and theBoard’s independent auditor in Reading, Pennsylvania.We performed fieldwork from May through September1997. We also referred to survey (Survey No. 01001-1-Ch) fieldwork conducted from January through May1997. We conducted the audit in accordance withGovernment Auditing Standards.

Methodology

To accomplish the audit objectives, our examinationconsisted of:


S Reviewing Federal laws, regulations, policies,and procedures relating to the Program,

S interviewing AMS officials, the Board and itsAdministrator, the Board’s major contractors, themajor advertising subcontractor, and the Board’soutside auditor,

S testing receipt and deposit of assessments andthe related expenditures and investments,

S visiting the Board’s major contractors andsubcontractor for the purpose of examining thecontractors’ accounting and other financialrecords,

S examining and analyzing AMS’ oversightdocuments and contract review policy, and

S visiting the Board’s outside auditor to examine hisaudit workpapers.


CHAPTER 3 - FINDING NO. 1AMS AND THE FLUID MILK BOARD NEED TO

STRENGTHEN THEIR CONTROL OF THE PROGRAM

AMS effectively left all oversight responsibilities to theBoard, and the Board, because it had no employees,left its oversight responsibilities to the contractors itrelied on for administrative services. We concludedthat because AMS did not provide proper oversightand direction, the Board (1) allowed the payment ofover $127 million in expenses that were not supportedby AMS-approved contracts (see Finding No. 2),(2) surrendered its ability to enforce compliance bycontractors and subcontractors (see Findings Nos. 4and 5), and (3) had not maintained approved minutesof Board meetings (see Finding No. 4). Other than theopinions of its contractors/subcontractors, the Boardhad little information as to the effectiveness of itsProgram. Another responsibility of both AMS and theBoard was to analyze the advertising, promotion, andresearch activities carried out with Program funds todetermine whether they had increased fluid milkconsumption. As of the time of our audit, neither entityhad done this.

Section 1999H of the Act defines the powers andduties of the Board, including the requirement that allcontracts and agreements be approved by theSecretary. It also states that the Board must keepminutes, books, and records that reflect all of the actsand transactions of the Board and promptly reportminutes of each Board meeting to the Secretary.Section 1999B of the Act states that the purpose of theProgram is to carry out an effective program ofpromotion, research, and consumer education to


strengthen the position of the dairy industry in themarketplace and to maintain and expand markets anduses for fluid milk products. Section 1990O(b) of theAct states that the Secretary shall terminate orsuspend the operation of the Order whenever he findsthat the Order does not effectuate the declared policyof the Program. Section 1999C of the Act definesadvertising as a program directed toward increasingthe general demand for fluid milk products.

The Board has chosen to use contractors to performits managerial and administrative functions instead ofhiring its own staff. The Board did not consider theProgram to be permanent and did not want theobligations of hiring a permanent staff. Thus, theresponsibility of ensuring contract compliance restslargely with the contractors themselves. We questionthe independence of some of the key contractoremployees who have been assigned responsibility forBoard activities; it is sometimes unclear whether theseemployees' concerns lie primarily with the Board orwith their own employer, the contractor. The followingflow chart shows the major contractors used by theBoard.

1

1

1

1



When we issued our Management Alert in May 1997,the contract for the Board’s Administrator was $75,000per year. Beginning in July 1997, it changed to$100,000 per year. (At the exit conference, we wereadvised that the contract increased in February 1998to $180,000 for 23 hours of work per week.) Thecontract also allowed the Board’s Administrator tocharge related expenses, such as travel, that are inaddition to the $100,000 for his personal services.The Board’s Administrator bills for his services at arate of $150 per hour (which would equate to anannualized cost of $312,000). This billing rate and theBoard Administrator’s contract amount ($100,000)would allow him to charge 13 hours per week foroverseeing the Board’s activities. We continue toquestion whether this 13 hours per week is enoughtime to properly administer a $120-million-per-yearprogram.

- The Board’s Administrator also has majorresponsibilities to his CPA firm. This CPA firmhas a contract to provide the Board with allrequired financial and accounting services. TheCPA firm has another contract with the Board toprovide compliance reviews over other Boardcontractors. Altogether, the Board’sAdministrator, either as an individual or throughhis CPA firm, is a party to three contracts withthe Board as a sole-source contractor.

- Person A’s CPA firm also provides financial andaccounting services to at least two other USDApromotion and research boards.

- Person A also has a commercial business as afinancial advisor to other individuals.

The following flow chart illustrates the above:



Because of all these other responsibilities, wequestion whether this Board Administrator hasadequate time to devote to the Board’s needs. Wequestion whether these other commitments may haveprevented him from ensuring AMS contract approvalprior to making payments and from enforcingcontractor compliance. Additionally, since Person Ais a principle in the CPA firm providing accountingservices to the Board, neither the CPA firm norPerson A has the independence required for suchservices.

The Board’s contract with MIF requires that MIFappoint one of its employees as Executive Director ofthe Milk Processor Education Program (MilkPEP). MIFcontracted with IDFA for the services of one of itsemployees to act as Executive Director of MilkPEP (Person D). We question why the Board would haveentered into a contract with MIF for this employeewhen the Board was fully aware that MIF had noemployees.

The MIF contract with IDFA requires IDFA to perform(or have others perform) all tasks detailed in thecontract between the Board and MIF. From July 1through December 31, 1996, the MilkPEP ExecutiveDirector charged an average of 47 hours per week tothe Program. As Executive Director (Person D), he isresponsible for coordinating the creation,development, and implementation of promotioncampaigns approved by the Board. We believe thatsince the Executive Director is working full-time onBoard activities, the Board should determine if this isthe most effective means of obtaining these services.

About $127 million in payments were made before thecontracts were approved by AMS. (See FindingNo. 2.) The Board could have controlled contractpayments had it required that its management monitor


compliance with the Act and the Order. Except forBoard members, all those reviewing and approvingcontract expenditures were themselves contractors orcontract employees. We believe that this near totalreliance on contractors and contractor employees hasresulted in a lack of independence which AMS and theBoard should address.

The Board’s contract with MIF requires that it submitmonthly progress reports and authorization requestson all projects that it is overseeing for the Board. (SeeFinding No. 4.) Although these reports have beenrequired since July 1994, MIF has never submittedthese reports. These reports would have provided theproject description, the objective of the project, theplanned strategy, the expected benefit to the milkindustry, the cost, and the method by which thesuccess of the project would be evaluated. Had thesereports been submitted to the Board, it would havebeen able to more effectively monitor progress in thevarious Program areas.

The Board did not timely monitor Program expensesto determine whether contractual limits wereexceeded. (See Finding No. 4.) The Board's contractfor an Administrator (Person A) for the periodAugust 30, 1996, through June 30, 1997, had aspecified dollar limit, including expenses. Although itwas the Board Administrator’s responsibility to monitorcontract compliance of all contracts to which the Boardwas a party, he allowed the contract limits for hispersonal contract as Board Administrator to beexceeded for 2 consecutive months.

The Board relied on IDFA personnel to prepare andmaintain official minutes of Board meetings. (SeeFinding No. 4.) Both IDFA and AMS provided usminutes of Board meetings; however, there werematerial differences in the two sets of minutes


provided. The Board Administrator told us that he was“reconstructing” the official minutes. Without officialBoard minutes, we could not determine whichcontracts and budgets the Board had approved. Wequestion how the Board’s Administrator can“reconstruct” official minutes of Board meetings heldsince 1994, as he was only appointed to the positionin 1996.

Neither AMS nor the Board ensured compliance withthe Act or the Order. We found no evidence that ananalysis had been performed by either AMS or theBoard to determine whether the advertising,promotion, and research activities carried out withProgram funds increased consumption of fluid milk.The Board Administrator informed us that a study hadnot been done and that he did not believe the Board oranyone wanted to know whether the Board’s activitieshad increased fluid milk consumption.

In its Report to Congress, dated July 1, 1997, AMSreported the results of a study that it hadcommissioned from the Economic Research Service(ERS). ERS performed an examination of the effectsof generic advertising on fluid milk sales. This studyshowed that fluid milk sales were up 5.9 percent fromthe period October 1995 through September 1996when compared to the previous 12 months. Thereport states “Sales increases due to the Dairy andFluid Milk Acts stem from increases in advertisingdollars, their effectiveness, and a marked upward shiftin fluid milk demand in the post-Act period thatpartially offsets a downward trend in consumption overtime. It is possible that factors other than advertising(e.g., increased public concern about calcium intake)caused some shifts in the consumer demand for milkduring the post-Dairy Act Period. Thus, the analysismight overstate the actual effect the Dairy and FluidMilk Acts had on increasing the advertising/sales


response for a given level of expenditures.” The ERSstudy does not show AMS the specific results of theadvertising by the National Fluid Milk ProcessorPromotion Board.

In its 1997 Annual Report To Congress, AMS reportedthat fluid milk sales increased 5.9 percent fromOctober 1995 through September 1996 whencompared to the previous 12-month period. In its1996 Report To Congress, AMS reported fluid milksales of 23.3 billion pounds from October 1994through September 1995 and in its 1997 Report ToCongress, AMS reported sales of 23.5 billion poundsfrom October 1995 through September 1996; that isan increase of only 0.85 percent. AMS officials couldnot explain this apparent conflict ( 5.9 percent reportedversus 0.85 percent calculated by OIG) to us. Wethen made similar comparisons for previous periodsand found similar discrepancies in sales increasesreported by AMS, as shown below:

ANNUAL REPORT (BILLION YEAR TO NEXT ANNUALPERIOD POUNDS) (SALES DECREASE) REPORT

AMS REPORTED COMPUTED SALESFLUID MILK INCREASE AMS SALES

SALES FROM PREVIOUS INCREASE IN

FLUID MILK OIG

10/93 - 9/94 22.9 1/ 4.7%

10/94 -9/95 23.3 1.75% 4.2%

10/95 - 9/96 23.5 0.85% 5.9%

10/96 - 9/97 23.4 (0.42%) 2/

1/ Data unavailable for calculation.2/ The 1997 report was not completed at the time of our review.

The above chart shows wide variances between whatAMS reported each year in its annual report and ourcalculations when comparing one year’s report to thenext. AMS officials could not explain these differencesto us. We believe this demonstrates that anindependent study of the effect of the fluid milk


Recommendation Suspend Board activities until AMS and the BoardNo. 1a jointly develop a plan for restructuring its management

AMS’ Response AMS officials did not agree to suspend Board

assessments and subsequent advertising is needed tosupport the continuation of the program. In addition,since no payments were made from the reserveaccount described in Finding No. 5, we believe thisprovides further evidence of the questionable extent ofsales increases.

ERS officials informed us that a separate study couldbe performed; however, it would have to be designedproperly and would take a greater effort than theyhave previously been performing. More specifically,in its letter to AMS dated April 15, 1998, ERS statedthat, “Any current attempt to evaluate the twocampaigns separately would require advertisingvariables that were unique to each campaign andbased upon consumer responses to each program.Such a model would require sampling and estimationprocedures which are beyond the time and resourcesof the (ERS) Evaluation Committee.”

of Board activities.

activities. Rather, they, along with the Board,developed a plan for restructuring the management ofthe Board’s activities. AMS advised that the Boardagreed to hire a full-time employee to oversee allBoard activities. AMS discussed several othercorrective actions in its response including: Thepossibility of having a CPA firm audit the Board’sinternal control system, requesting the Board toterminate all contracts with MIF, and requesting theBoard to identify all lobbyists and lobbyingorganizations in all Board contracts and subcontracts.AMS’ target date is December 31, 1998.


OIG Position AMS should suspend the Board’s activities until aspecific plan has been developed to restructure theBoard’s management of Board activities. Theresponse provided does not contain specific correctiveactions to enable us to reach management decision onthis recommendation.

In order to reach management decision, AMS needsto suspend Board activities until they have developedand provided us a detailed corrective action planregarding (1) a restructured Board and its operatingplan; (2) termination of the MIF contracts; and(3) revision of the contract/subcontract provisions torequire disclosure of lobbyists and lobbyingorganizations. Since we are recommending that theBoard be restructured, we do not believe it isappropriate to conduct a review of the Board’s internalcontrol system.

We support the Board’s resolution to hire a full-time“employee” (Administrator) to oversee all activities.To ensure independence, the Administrator needs tobe organizationally and physically independent of allexternal impediments. The Administrator should havesole responsibility to the Board and be responsible forall Board management and administrative functions.In addition, AMS needs to advise us as to the futurerole of the current Board Administrator, including hisduties and responsibilities, if any.

AMS has advised that the target date forimplementation is December 31, 1998. However,AMS needs to develop intermediate action dates sinceall the actions cannot be accomplished simultaneouslyand some are dependent on others. AMS shouldprovide a timeline for the proposed corrective actions.


RecommendationNo. 1b

AMS’ Response

OIG Position

Require the Board to determine the effectiveness of itspromotion and research activities in increasing fluidmilk consumption.

AMS recognized the importance of evaluating theeffectiveness of the promotion programs and that suchevaluations were required by the enabling legislation.AMS agreed to develop a request for proposals toconsider new or revised methodologies for evaluatingthe effectiveness of the advertising campaignsconducted by the Board and it will include thefeasibility of evaluating the programs of the Boardseparately from other dairy promotion programs.AMS’ target date for the evaluation contract isFebruary 27, 1999.

In order to reach management decision, AMS needsto provide us with its final plan for evaluating theprogram and the timeframe for the evaluation.


CHAPTER 4 - CONTRACT PROCEDURES DID NOT COMPLY WITH REQUIREMENTS

OF THE ACT AND/OR ORDER

Finding No. 2 C AMS allowed the Board to commit and/or expendThe Board Made Program funds for 108 contracts, even though itContract Payments had approved only 3 of these contracts prior toThat Were Not the contracts’ effective dates. AMS had notApproved By AMS provided proper oversight, as evidenced by the

The Board, with limited AMS involvement, assumed theauthority to determine the activities it contracted for, thevendors it used, and the price it would pay for theservices it received. In most cases, the Boardcontracted for services without AMS approval. InMay 1997, we issued a Management Alert whichdiscussed this issue. In response, AMS and the Boardmade changes which we do not believe fully addressour concerns as described below.

numerous contracts, obligations, and paymentsmade by the Board without AMS’ approval. In theabsence of AMS constraints, the Board operatedthe Program as it saw fit. The former BoardChairman told us that the Board was responsiblefor the milk promotion funds and that it couldspend the funds as it felt was appropriate.Between December 10, 1993, and June 17, 1997,the Board collected over $168 million inprocessor assessments. During the same period,the Board authorized the expenditure of$127 million, 75 percent of the total assessments,without AMS' approval.

Section 1999H(c)(8) of the Act and Section1160.209(g) of the Order require that AMSapprove all contracts prior to the expenditure ofProgram funds.


In a 1992 audit (01099-2-Ch) of a similar dairyboard, we reported deficiencies similar to thoseidentified here, and AMS agreed to correct them.AMS agreed to discontinue retroactivelyapproving contracts. That board had entered intocontracts involving work done prior to AMS’approval. It was agreed that this was acceptableso long as there was no actual or impliedobligation of the board prior to AMS’ approval ofthe contract. That board’s current procedure is tosubmit all of its contracts and subcontracts toAMS for review. We believe that AMS shoulduse the same policy and procedures foroverseeing the Fluid Milk Board.

The Board’s first contract with MIF was for theperiod July 28, 1994, through December 31,1996. This was the primary contract throughwhich the Program would operate and AMS didnot give its approval until 2 years and 8 monthslater. The Board signed this contract onAugust 26, 1994; MIF signed it on September 19,1994. The Board did not obtain AMS’ approval ofthis contract until April 16, 1997; this was after wehad begun our audit and over 3 months after thecontract had expired. Although the contractstated that, “MIF and Board agree that thisAgreement shall become effective only upon theapproval of this Agreement by the United StatesDepartment of Agriculture," AMS did not approvethe contract until after we questioned whether thecontract had been approved. By that time, theBoard had paid MIF over $3 million and MIF, inturn, had contracted with an advertising firmwhich had spent over $123 million. AMS, theBoard, and MIF were all aware that, according tothe Act and the Order, no payments werepermitted until AMS had approved the contract.


The subsequent contract between the Board andMIF for the period January 1, 1997, throughDecember 31, 1998, was not signed by the Boarduntil February 3, 1997, or by MIF until February 5,1997. Again, AMS did not approve this contractuntil April 16, 1997, subsequent to the initiation ofour audit.

Even though it did not have the authority to do so,MIF entered into an agreement with a majoradvertising agency to provide most of the Board'sadvertising, public relations, and research. Theagreement between MIF and the advertisingagency was effective on May 1, 1994, almost3 months before the Board was seated onJuly 27, 1994, and almost 3 years before AMSpost-approved the MIF contract on April 16, 1997.

MIF and the advertising agency entered into asubsequent agreement for the period July 1,1996, through December 31, 1998. AMS post-approved this contract over 10 months later onMay 8, 1997, and for a different period (July 1,1996, through July 31, 1998). None of the$123 million paid to the advertising agencyshould have been paid until AMS approved thecontracts.

Other expenditures made prior to AMS’ contractapproval included payments to Person A’s CPAfirm, an attorney for the Board (Person C), and forpromotional expenses.

We identified payments made for 108 contracts;however, neither AMS, the Board, MIF, nor IDFAcould furnish us with copies of 37 of thesecontracts. We have no evidence to cause us toquestion the existence of the 37 contracts, manyof which were for individual celebrities to be


Recommendation Require the Board to obtain AMS approval on allNo. 2a contracts, subcontracts, and agreements before

AMS’ Response AMS agreed to revise its September 17, 1997,

photographed for the milk- mustache advertisingcampaign. We found celebrity photographs andother evidence that Program funds wereexpended for Program-related expenses;however, we could not locate the specificcontracts. We believe the Board's inability tofurnish the 37 contracts in question is furtherevidence of its lack of internal controls overcontracting. Of the 71 contracts available forreview, 33 were not signed by at least one of thecontracting parties prior to the contracts' effectivedates. AMS had not approved 68 of the 71contracts we reviewed prior to the contracts'effective dates.

In its response to our Management Alert, datedMay 6, 1997, AMS stated that it would direct theBoard to cease payments for contracts,subcontracts, and agreements that had not beenapproved by AMS. AMS also stated that it wouldrequire that the Board submit all contracts andsubcontracts for its review. This requirement wasincluded in the AMS letter to the BoardAdministrator, dated August 15, 1997. However,on September 17, 1997, AMS agreed with aBoard counterproposal that AMS’ prior approvalwould only be required for nine contracts.

any funds are obligated or expended.

contract approval process to require that it reviewand approve all of the Board’s contracts andsubcontracts. Also, all of the Board’s contractsand subcontracts are to contain language that nopayments are to be made prior to Secretarialapproval of the contract or subcontract. AMS did


OIG Position We did not recommend that purchase orders be

Recommendation Require the Board to establish a contract controlNo. 2b system that will ensure compliance with the Act,

AMS’ Response AMS agreed with this recommendation and will

OIG Position We agree with the proposed corrective actions.

Finding No. 3 C We reviewed 71 contracts and subcontracts andContracts Did Not determined that 61 did not contain specificInclude Certain language required by the Act and the Order.Required Language Adequate oversight had not been provided by

not agree to require the Board to submit sub-subcontracts or purchase orders to AMS. AMS’target date is September 30, 1998.

submitted for AMS’ review and approval.However, we continue to believe that AMS shouldobtain and approve all contract documents(including contracts, subcontracts, sub-subcontracts, etc.,) for this Board, just as it doesfor the dairy producers’ board. AMS needs todevelop criteria, based on the vulnerabilities, todetermine the extent of the review which it willperform on each of the proposed contracts. Toreach a management decision, AMS needs toprovide us with its plan to implement a contractreview and approval process which will ensureproper oversight of Board contracting activities.

the Order, and AMS guidelines.

work with the Board to develop a system to trackcontracts, subcontracts, and sub-subcontracts bySeptember 30, 1998.

To reach a management decision, AMS needs toprovide us with an outline or overview of thesystem and Board concurrence to implement thesystem.

AMS or the Board to ensure that these specific


required terms and conditions were included in allcontracts and subcontracts. Because therequired language was not included in contracts,the Board did not obtain title to some assetsdeveloped with Program funds, records were notrequired to be made available for audit, andcontractors were not informed that Secretarialapproval was required prior to contract execution.

Section 1999H of the Act states that the Board’sduties include entering into contracts andagreements with the approval of the Secretary.Section 1160.209(g) of the Order states that anysuch contract or agreement shall provide that theplan or project shall be adopted upon approval ofthe Secretary and that the Secretary periodicallymay audit the records of the contracting party. The guidelines for AMS oversight of commodityresearch and promotion programs, signed by theAMS Administrator on April 19, 1994, state that“* * * AMS will require boards to formally notifypotential contractors that any work theyundertake prior to contract approval by USDA isat their own risk, as boards are not financiallyliable if the contract is not approved by USDA.”

Section 1160.505 of the Order states that anypatents, copyrights, trademarks, or publicationsdeveloped through the use of Program funds arethe property of the U.S. Government asrepresented by the Board.

The Board’s contract with MIF, and MIF’ssubcontract with the major advertising agency,contain the necessary language which states thatthe Board will take title of said assets, etc.However, the subcontract between the majoradvertising agency and the photographer did nothave the necessary asset ownership language.


We addressed this issue in our ManagementAlert.

The Board has primarily used one photographerfor the highly recognized milk-mustacheadvertising campaign. The contract allows forthe Board to have the right to use one photographtaken during a photography session for15 months. Any usage of that photograph afterthe 15-month period requires that thephotographer receive an additional royalty. The“customary and usual” royalty which thephotographer requires for such renewals is$12,500 for 15 additional months.

About $129,000 has been expended for renewingroyalties on photographs for which the Board hadnot taken title. If the advertising agency’scontract with this photographer had contained therequired language, the Board would have ownedthe photographs and no additional fee to thephotographer would have been required. PersonA’s CPA firm informed the Board of thisdeficiency in a 1995 compliance review; however,as of our audit fieldwork completion date, theBoard still had not required that contracts berevised to ensure that the Board assumed itsrightful ownership of these assets.

On August 15, 1997, the Agricultural MarketingService (AMS) sent a memorandum to OGCasking them to review a revised contract beingproposed for subsequent photography sessions.AMS asked OGC to review the proposed contractto determine if it was “legally sufficient.” OGCconcurred that the revised contract was “legallysufficient.” In our discussions with OGC, we weretold that “legally sufficient” means requiring theSecretary’s approval of budgets and contracts


Audit Requirements Although we were not denied access to any

before payment can be made and requiring thatthe Department have the authority to auditcontractors’ records. The question properlyphrased to OGC would have been whether theproposed contract adequately addressedrequirements in the Order that the Board mustassume title of assets developed or acquiredusing Board funds. During our audit fieldwork,we concluded that the Board still has not takencontrol of assets developed with Program funds.The Board still has to pay royalties forphotographs after 15 months of usage. Thephotographer still has control and possession ofthe photographs and negatives which weredeveloped with over $2.7 million of Programfunds.

On February 10, 1998, OGC issued an opinionwhich stated that the photographs were owned bythe photographer because the contract betweenthe photographer and the advertising agency hadno provisions regarding the Government’sownership of the property. If the contract for thephotographs provided that the ownership of thephotographs belonged to the Board, then theowner would not be the photographer. OGCfurther stated that the Board could negotiateaway its rights to the property if it was in itsinterest to do so. We concluded that the contractwith the photographer should have had languagesimilar to language in the contract between MIFand the advertising agency, which provided thatthe Board would have ownership of the assets.Appropriate oversight by AMS would have notedthe deficiency in this contract.

records at contractors or subcontractors, 57 ofthe 71 contracts, subcontracts, etc., we reviewed


Recommendation Require that contracts, subcontracts, etc.,No. 3a contain all provisions mandated by the Act and/or

AMS’ Response Other than the ownership issue, AMS did not

OIG Position To reach management decision, AMS needs to

Recommendation Require the Board to obtain title and possessionNo. 3b of all assets developed or acquired with Program

AMS’ Response In response to Recommendation No 3a, AMS

did not contain language requiring that records bemade available to USDA for audit. All contractsshould contain the mandatory language.

Without the required language, contractors andsubcontractors may not be aware that, withoutSecretarial approval, the Board is not authorizedto pay expenses incurred under these contractsand subcontracts, and that their records aresubject to review by USDA.

Order.

address the provisions mandated by the Actand/or Order, such as the access to records foraudits and required Secretarial approval of allcontracts.

address all provisions mandated by the Actand/or Order, including Secretarial approval ofthe contracts and access to records by USDA.

funds.

disagreed with the Report’s interpretation as tothe ownership of copyrights. To prevent furthermisinterpretation, the Board submitted aproposed change to the Order that would clarifythe ownership issue. The public comment periodon the proposed rule ended June 22, 1998, andAMS is preparing a final rule.


OIG Position While AMS disagreed with this recommendation,

Finding No. 4 C The Board did not require contractors to provideProgress Reports deliverables specified in contracts and did notWere Not Submitted establish controls to prevent contractualand Expense Limits expenditure limits from being exceeded. InWere Exceeded addition, the Board’s Administrator submitted and

its action taken in response toRecommendation No. 3a, preparation of anamendment to the Order addressing theownership issue, resolves this issue. Theproposed amendment will require that anagreement on ownership be reached between thecontracting parties and included in the contract.However, this action was unnecessary becausethe OGC opinion dated February 10, 1998, statesthat the Board can negotiate ownership rights.To reach a management decision, AMS needs toprovide its plan for assuring that it will require theBoard to document said negotiations and that theresults thereof will be included in its contracts.

was paid for two claims for personal services thatexceeded contract limits.

The guidelines for AMS oversight of commodityresearch and promotion programs, signed by theAMS Administrator on April 19, 1994, state that“* * * AMS will require boards to monitor contractsfor compliance with all provisions.”

The Board’s contracts with MIF required threespecific reports: Monthly progress andperformance reports, requests for the obligationof funds, and overall evaluation reports for eachindividual project administered by MIF. However,MIF did not submit these reports to the Board.These reports would enable AMS and the Boardto evaluate the effectiveness of the projects andthe progress being made on them.


The Board’s contract with MIF also required thatit provide secretarial support for the Board and itsofficers. Since MIF did not have any employees,it relied on IDFA employees to prepare andmaintain the official minutes of Board meetings.The copy of the "official" minutes we obtainedfrom the IDFA employee differed from the copy ofthe "official" minutes we obtained from AMS.From our review of the Board minutes provided tous, we could not determine which contracts andbudgets the Board had approved. The BoardAdministrator told us that he was “reconstructing”the official minutes and that the reconstructedminutes would be available within "a couple ofmonths." Given the passage of time andconflicts within the copies of minutes alreadyprepared, we question how the Board’sAdministrator would be able to construct accurateBoard minutes from a period prior to hisappointment. Subsequent to the completion ofour audit fieldwork, we were advised that theBoard minutes would be recorded by the outsidelegal counsel and the official copy would bemaintained by the Board’s Administrator.

The Board’s contract for its Administrator for theperiod August 30, 1996, through June 30, 1997,was for $75,000, including expenses, for 9 hoursof work per week. The Board’s Administratorclaimed and received two payments totaling$14,381 in excess of the contract limits. Theseoverpayments indicated that the internal controlswere either inadequate or were not working. Webrought these overpayments to the attention ofAMS and the Board’s Administrator. The Board’sAdministrator then requested, and the Board andAMS approved, a retroactive increase in thecontract limit subsequent to the end of thecontract period.


Recommendation Establish controls to ensure that (1) the BoardNo. 4a requires contractors to fully comply with

AMS’ Response AMS agreed with this recommendation. The

OIG Position We agree with the proposed corrective action.

Recommendation Discontinue retroactive approval of the Board’sNo. 4b contracts, subcontracts, and amendments.

AMS’ Response AMS agreed that it will notify the Board that

contracts, (2) the Board does not allowcontractors to exceed contractual budget limits,and (3) the Board requires submission ofdeliverables.

Board has reviewed and revised its contractapproval and payment system. Payments aremade after a thorough review by the BoardAdministrator to ensure compliance. AMS hasestablished a system to ensure compliance andreceipt of deliverables. AMS also will require theBoard to submit a report within 60 days to ensureprovisions in contracts and subcontracts arebeing met.

However, to reach management decision, weneed to be advised of the specifics of theproposed plan for the Board’s system to verifypayments and deliverables. We also need morespecific information on how AMS will review andtest the Board’s contract controls and not relysolely on self-certifications provided by theBoard. The value of a one-time report preparedby the Board stating that provisions in itscontracts and subcontracts are being met is notsufficient.

contracts, subcontracts, etc., should containprovisions indicating that any work performedprior to AMS’ approval is at the risk of the


OIG Position To reach a management decision, we need a

Finding No. 5 C Some Board contracts and subcontracts hadContract Terms Were provisions that were not being complied with. AsNot Being Met a result of the material contract breaches, either

contractor. This is to be accomplished bySeptember 30, 1998.

copy of the AMS notification to the Board.

party to the contracts could terminate them.Consequently, the Board might not be able toenforce contract terms, and importantdeliverables, advertising campaigns, andresearch analyses might not be provided.

MIF’s subcontract with the advertising agencyrequires that MIF establish and maintain areserve for the potential payment of an incentivecommission of approximately $350,000. Thisincentive commission was to be paid if milk salesincreased over the previous year because of theadvertising campaign. MIF has never paid anincentive commission and has never establishedsuch a reserve account. Similarly, the Board hasnot established a reserve account to reflect thisliability.

MIF’s contract with the Board requires that MIFpay its subcontractors and claim reimbursementfrom the Board. As these expenses increased,rather than paying the expenses and seekingreimbursement, MIF began submitting allinvoices from the advertising agency directly toPerson A’s CPA firm for payment. The procedurechanged again in 1997, at which point theadvertising agency began sending its invoicesdirectly to Person A’s CPA firm, while submittingduplicates to MIF for approval.


Recommendation Require the Board to enforce contractors’No. 5 compliance with the terms of their contracts.

AMS’ Response AMS did not address the issues developed in this

OIG Position We cannot reach management decision until

Finding No. 6 C The Board had not followed good businessThe Board Used Sole- practices by competitively negotiating forSource Contractors contractual services. There was no evidenceWith No Evidence of that the Board made an analysis to ensure that itOther Contractors was obtaining its contracted goods and servicesBeing Considered in the most cost-effective manner. For example,

finding.

AMS adequately addresses the establishment ofthe contingent liability and the payment of bills.

we found that a subcontract for the Board’sadvertising and public relations activities with amajor advertising agency was let withoutcompetition. Of the Board’s $131 million inProgram expenses, $123 million (93 percent ofProgram expenses) was spent with thisadvertising agency. As a result, the Board mayhave overpaid for services and may not beobtaining the objective, professional opinions andservices it expects to receive.

In a 1992 audit of another dairy board(01099-2-Ch), we reported that goods andservices were being obtained without competitivebidding. We recommended that AMS ensure thatthe board obtain goods and services in the mostcost-effective manner, and AMS agreed inprinciple with this recommendation.

The Board's largest contract is for MIF to handleits day-to-day operations. However, there is noevidence that the Board solicited bids, orconsidered other vendors for this service. Since


Program inception, the Board has paid MIF over$3 million for its services. We believe the Boardshould have explored other options for obtainingthese services rather than issuing a contractwithout competition.

We were recently advised that, according to theOrder, the Board was required to select MIF tocarry out Program functions during the initialfiscal period. Our review of the implementingregulations disclosed that they allowed, but didnot require, the Board to select MIF for the initial30-month fiscal period. The order required that ifan organization such as MIF were selected, theBoard had to determine that its selection was“practicable” and also obtain the approval of theSecretary. We found no evidence that anevaluation was done to determine whether theselection of MIF was practicable. In addition, theBoard did not obtain the Secretary’s approval forits contract with MIF until April 16, 1997, whichwas after the initial fiscal period had expired.Even after the initial fiscal period, there is noevidence that the Board considered any otheroptions for obtaining these services.

Most of the Board’s advertising and publicrelations activities ($123 million) are handled bya large worldwide advertising agency. Again, wefound no evidence that the Board considered anyother advertising agency before this contract wasexecuted or renewed. In June 1998, we wereprovided information which stated that the Boardconsidered other advertising agencies beforeselecting the contractor used. The evidenceprovided was in the form of a letter on a dairycompany letterhead to MIF dated March 15,1991, discussing potential advertising agencieswhich MIF should consider. However, this is


irrelevant because the Secretary did not appointthe first National Fluid Milk Processor PromotionBoard until June 6, 1994.

It was recently pointed out that Board minutesdated August 30, 1994, confirmed the Board’sselection of the advertising agency. However,the minutes indicated that representatives fromonly one advertising agency were present andthere is no documentation of cost data beingpresented for analysis. Those minutes indicatethat the Board approved the advertising planswhich the advertising agency had developed. Noevidence was provided which showed that theBoard considered awarding the advertisingcontract to other advertising agencies.

When the Board wanted to develop an InternetWEB site, the advertising agency had one of itswholly-owned subsidiaries develop the site. Theadvertising agency provided us withdocumentation that requests for proposals weresent to four prospective WEB site developers,including their own wholly-owned subsidiary.Three, including the subsidiary, responded.However, based on our review of the informationprovided, the advertising agency gave insiderinformation to its subsidiary enabling it to beawarded the contract. It was clear that there wasno competition for the contract. The advertisingagency instructed its subsidiary, after the duedate for submitting proposals and after the otherprospective vendors submitted their proposals,on how much money was available and how toproceed to revise its initial proposal. (Seeexhibit E.) Further correspondence from theadvertising agency to its subsidiary datedJune 13, 1996, advised that, “We have $225,000in the budget that must cover all of (the


Recommendation Require the Board to discontinue awarding sole-No. 6 source contracts, subcontracts, etc., and

AMS’ Response AMS agrees in principle with this

subsidiary's) professional time and out-of-pocketexpenses for creating and maintaining the Website during Phase 1 (launch), Phase 2 andPhase 3.” Essentially, the advertising agency setthe contract amount.

The Board has three contracts (all of which havebeen renewed) with the Board’s Administrator(Person A) and/or firms in which he has aninterest. In addition to its contract for his servicesas Board Administrator, the Board has anothercontract with Person A’s CPA firm for overseeingthe collection of assessments and providingaccounting services for the Board. Person A’sCPA firm also has a contract to performcompliance reviews of the Board's majorcontractors: MIF, IDFA, and the majoradvertising agency. These close relationshipsraise questions about the independence of thevarious firms/organizations involved and whetherthe Board paid a fair price for the servicesobtained. We were not provided documentationwhich showed that the Board considered anyother contractors to perform these services orthat these fees were compared to fees chargedby other firms.

establish guidelines for awarding contracts toensure that competition is sought and thatcontracted goods and services are obtained inthe most cost-effective manner.

recommendation and will notify the Board that itshould document a competitive process to selectcontractors to carry out the program. Theselection should be based on the Board’s


OIG Position To reach a management decision, we need the

Finding No. 7 C The Board’s financial services contractorFinancial Statements presented financial statements that did notWere Incorrect accurately reflect the Board’s financial condition,

judgment of costs versus benefits and of otherrelative factors and considerations, but will not berequired to select the lowest bidder.

AMS notification to the Board requiring acompetitive process for contracts. The processmust include documentation of selection criteriaand require an explanation of cost and technicalevaluation for awards.

and the Board’s contract with its independentauditor did not require audits to be performedusing generally accepted Government auditingstandards (GAGAS). AMS required that theBoard audit be performed using generallyaccepted auditing standards. AMS did notrequire that the audit include tests for compliancewith laws and regulations.

The Board presented financial statements thatdid not reflect the actual financial condition of theBoard. This was caused by misrepresentationsmade by the Board's financial servicescontractor, Person A. Had the Board disclosed inits statements that it was spending Programfunds without the Secretary’s approval, wequestion whether the readers of those statementswould have let the Board continue to makepayments without this approval. Had theindependent auditor known that the Board hadnot secured AMS contract approval prior tomaking payments, it would have changed theresults of its audit reports. Representatives ofthe independent auditor told us they would have


issued a qualified opinion or, at a minimum, theywould have disclosed these irregularities.

The financial statements as of April 30, 1996, andas of March 31, 1995, contained materialomissions and questionable statements that, inthe aggregate, were significant enough to affectthe decisions of its users, including the Secretary,members of the U.S. Congress, and milkprocessors. These financial statements were inthe "USDA Report to Congress on the NationalDairy Promotion and Research Program and theNational Fluid Milk Processor PromotionProgram," dated July 1, 1997, and July 1, 1996.Examples of material omissions and misleadingstatements include the following.

The contingent liability of over $350,000for the incentive commission due to theadvertising agency was omitted from thebalance sheet. (See Finding No. 5.)

The notes to the financial statements didnot disclose the $127 million inexpenditures made without the Secretary’sapproval or any of the related-partytransactions. (See Findings Nos. 2 and 6.)

In management representation letters datedJune 8, 1995, and August 9, 1996, to the outsideCPA firm, the financial services contractor(Person A’s CPA firm) to the Board madequestionable assertions regarding internalcontrols and compliance with the Act and theOrder. He (Person A) asserted that:

The Board had complied with all aspects ofcontractual agreements that would have amaterial effect on the financial statements


in the event of noncompliance. However,although required by language within thecontracts and/or the Act and the Order, wedetermined that AMS had not approved 68of the 71 contracts available for our review.

No payments had been made whichexceeded the AMS-approved contractamounts. However, we found the BoardAdministrator’s contractual limit of $75,000for the period of August 30, 1996, throughJune 30, 1997, was exceeded in twoconsecutive months by a total of $14,381.

All contracts contained the key elementsrequired by the Act and the Order. Weconcluded that several key elements wereomitted from contracts, such as USDA'sright to audit contractor records and therequirement that expenses could not bepaid prior to the Secretary's approval, etc.(See Finding No. 3.)

The Board did not require audits of its records tobe performed using GAGAS; AMS did not requirethat audits be conducted using GAGAS. As aresult, the audits did not reflect the actualfinancial condition of the Board.

Section 1999H(h)(2) of the Act requires theBoard’s books and records to be audited by anindependent auditor at the end of each fiscal yearand to submit the audit to the Secretary.Paragraph 1.1 of the 1994 revision of theGovernment Auditing Standards requires non-Federal auditors to comply with GAGAS whenthey audit Federal programs. These standardspertain to auditors’ professional qualifications andthe quality of audit effort. Paragraph 4.15 states


that auditors should obtain an understanding ofthe possible effects on financial statements oflaws and regulations that are generallyrecognized by auditors to have a direct andmaterial effect on the determination of amounts inthe financial statements. Paragraph 4.18 statesthat the term “noncompliance” has a broadermeaning than illegal acts. “Noncompliance”includes not only illegal acts, but also violationsof provisions of contracts. Using GAGAS,auditors have the same responsibilities fordetecting material misstatements arising fromother types of noncompliance as they do fordetecting those arising from illegal acts.Paragraph 4.19 states that auditors shoulddesign the audit to provide reasonable assuranceof detecting material misstatements resultingfrom direct and material noncompliance withprovisions of contracts.

None of the audits of financial statements issuedsince the inception of the Program have beenperformed using GAGAS. The Board contractedfor audits of its financial statements for the fiscalperiods ending June 30, 1997, April 30, 1996,and March 31, 1995; however it did not requirethat GAGAS be used. At the time of our review,we found no evidence that AMS had approvedany of the audit contracts.

The Board’s agreement with Person A’s CPA firmto conduct compliance audits of the Board’s twolargest contractors does not require that theaudits be conducted using GAGAS, as theyshould. AMS approved these contracts onJuly 11, 1997, at a funding level not to exceed$28,000. Person A’s firm conducted twocontractor compliance audits in 1995 that also didnot comply with GAGAS.


Recommendation Ensure that the Board’s audited financialNo. 7a statements are issued using GAGAS.

AMS’ Response AMS did not agree to reissue past financial

OIG Position We agree with AMS’ corrective actions to require

Recommendation Establish controls to ensure that futureNo. 7b management representation letters addressed to

AMS’ Response AMS agreed to this recommendation by requiring

OIG Position We agree with AMS’ proposed corrective actions.

Recommendation Require the Board to ensure that contractorNo. 7c compliance audits are conducted using GAGAS.

AMS’ Response the Board Chairman and the Board Administrator

statements under GAGAS, but agreed to havethe Board’s next financial audit conducted underGAGAS.

the Board’s next audit to be conducted usingGAGAS. To reach a management decision, weneed a copy of the notification to the Board thatall future audits will be performed using GAGAS.

outside CPA firms correctly state the status of theBoard's financial, contractual, and legal position.

that the Board’s Chairman and Administrator bothsign the management representation letters toCPA firms regarding the Board’s financial,contractual, and legal position. In addition, AMSwill request copies of such letters for review.

To reach management decision, AMS needs toprovide us with the notification to the Boardestablishing this requirement.

AMS agreed to this recommendation by advising

that a GAGAS audit will be required for the fiscalyear ending June 30, 1998. AMS also is


OIG Position AMS agreed that it would require that its fiscal

reviewing its policy requiring audits for allresearch and promotion boards.

year 1998 audit be performed using GAGAS;however, it did not address the issue ofcompliance audits being performed usingGAGAS. To reach management decision AMSneeds to provide us with a copy of its notificationto the Board establishing this requirement for allfuture compliance audits.

USDA/OIG-A/01001-3-Ch Page 44

EXHIBIT A - AMS’ RESPONSE TO THE DRAFT REPORT


See exhibit B for OIG’s comments relating to Notes A-P.
































EXHIBIT B - OIG’S COMMENTS RELATED TO AMS’ WRITTEN RESPONSE


Following are excerpts from AMS’ written response (italicized) which OIG feelscompelled to address. (The AMS response is in exhibit A. Because they were sovolumnious, we did not include copies of all of the attachments provided with AMS’response.) The notes below correspond to the marked sections in exhibit A.

NOTE A: “To satisfy the concerns of the OIG, AMS will institute additional changes.”

AMS should not institute changes simply to satisfy OIG. Any changes AMS makesshould be to assure that the Program is operated in conformity with the requirementsof the Act and the Order. Concerns expressed by OIG evolved from AMS’ and theBoard’s nonconformity with requirements in the Act and the Order.

NOTE B: “Throughout the audit process and in particular since the Alert, AMS hasrepeatedly informed the OIG of changes instituted to address the OIG’s concerns.Nevertheless, the initial Report truncates its review 1 month after the Alert. Wewonder why the OIG was seemingly uninterested in evaluating current oversight andjudging both current practices and the adequacy of AMS’ reaction to the Alert. Thesecond draft of the Report does note these changes, but continues to base many ofits recommendations on past practices. Because a Management Alert is to sparkaction, it is disappointing that the Report does not fairly evaluate the responses takenby AMS and the Board.”

Our audit report, conclusions, and recommendations, by necessity, must reflect theresults of our audit testing. We acknowledged unconfirmed corrective actionsreported to have been taken, when appropriate.

We did not end our review 1 month after the Alert. Our audit covered the periodDecember 1993 through June 1997; however, our fieldwork continued for severalmore months. We have recognized changes reportedly made by AMS which wereported as unverified. We have requested many documents which would have hadan impact on our audit report; however, these documents have not been provided.We requested eight items from the Board Administrator on June 23, 1997, however,he still has not provided those items. These items included: Program evaluations



performed by MIF from 1994 through 1997; authorization request forms from 1994through 1997; and monthly summary reports of the services provided by MIF from1994 through 1997. The Board Administrator also has not provided us withdocuments we requested on June 27, 1997: (1) The officially approved minutes ofBoard meetings and (2) justification of the costs for the photography sessions andfor the development and maintenance of the Board’s Web site. Although an officialof the Board Administrator’s office advised us that all requested items would beprovided as soon as possible, we still have not received them. The BoardAdministrator had an obligation to us to either provide the documents we requestedor to advise that the documents did not exist; he did neither.

AMS makes the point throughout its written response (Exhibit A), and in previousmeetings held to discuss the audit results, that we did not properly reflect correctiveactions taken as a result of our Management Alert, which was issued in May 1997.We acknowledged many actions reportedly made by AMS on pages 5 and 6 and inother places throughout our report.

One of the actions AMS reportedly made in response to our Management Alert,which we recognized, was a change in AMS personnel. During our audit, AMS didmake a personnel change; however, when we asked the reason for the change,officials told us that the change was unrelated to our audit. Given the contradictorystatements AMS officials have made, we still do not know why changes in personnelwere made.

We also acknowledged that a new contract review process had been implemented;however, with the information provided, we were unable to fully assess what thereview process is. For example, in response to our Management Alert, AMS agreedon May 19, 1997, to “ * * * require that the Board submit all contracts andsubcontracts to the Department for review.” AMS revised its policy again onSeptember 17, 1997, which included a review and approval of about 9 contracts. Inits July 24, 1998, response to our official draft report, AMS stated that it “* * * willrevise its September 17, 1997, contract approval process with the Board to requirethat, in addition to all Board contracts, all contracts of the Board’s contractors bereviewed and approved by AMS.” We agreed with the change AMS made in



response to our Management Alert; however, we advised AMS that we did not agreewith the changes made on September 17, 1997. We also disagree with theproposed revision, as stated in AMS’ July 24, 1998, memorandum, because it doesnot include all contracts, subcontracts, sub-subcontracts, etc., which obligateProgram funds.

We asked for the officially approved minutes of Board meetings on June 27, 1997,and were told that they would be provided as soon as possible. During the audit weobserved two separate sets of Board minutes which contained conflictinginformation. The Board Administrator advised us that he was “reconstructing” theBoard minutes and that he would provide us copies within a few months. We havenot acknowledged corrective action taken in this area because we still have notreceived the copies which AMS advised us they have reviewed. We question howAMS can know that the minutes are accurate and complete when the copies AMSprovided to us conflicted with copies provided by Board officials.

Other unconfirmed actions taken or proposed include: Hiring a full time employee(Board Administrator), increased time and responsibilities for the current part-timeAdministrator, revised contracting requirements (language and approval), andrevised methods regarding preparation of minutes of Board meetings.

NOTE C: “The Report criticizes the Board for not owning the photographs taken bya renowned photographer. However, a legal opinion from the Office of the GeneralCounsel * * * states that Federal copyright law holds that the Board owns thecopyright to the advertisement while the artist retains the copyright to allphotographs. Though AMS has repeatedly shared this opinion with the OIG, theReport steadfastly avoids this conclusion. When the law is correctly interpreted, theBoard contracted for exactly what it wanted and what it got--photographs to use inits milk mustache advertising campaign.”

The real issue here is that, because of the lack of proper oversight by AMS and theBoard, a sub-subcontract with a photographer was written so that the Board’sinterest in the copyrights on the photographs to be produced was not properly



protected. The Board’s contract with MIF properly addresses property ownership,as does MIF’s contract with the advertising agency. However, the advertisingagency’s contract with the photographer did not expressly provide that thephotographs would be considered “work made for hire” nor that the Board would owncopyrights to the photographs produced. Because of these contract irregularities,the photographer owns the copyrights to the photographs. The contract for thephotographer contained all of the key elements of a “work made for hire.” Accordingto the OGC opinion, whenever there is a “work made for hire,” the contractor canreserve for itself the copyrights to works produced. Had the contract with thephotographer been written correctly, the Board would have owned the copyrights tothe photographs.

We did not disregard OGC’s opinion. It is evident that the opinion says that, as thecontract was written, the photographer owns the copyrights to the photographs.

The February 10, 1998, OGC opinion states that “ * * * the agreement with (thephotographer) did not expressly provide that the photographs would be considereda ‘work made for hire.’ If (the photographer) and the Board (through its advertisingagency), had expressly provided that the photographs were to be ‘work made forhire,’ then the copyright to them would not automatically belong to (thephotographer).” If the photographer and the Board (through MIF and the advertisingagency) had expressly agreed that the Board would own the copyright to thephotographs, the Board would not have had to pay the additional royalty rightstotaling $129,000 for the use of the photographs. This is a classic example of whyAMS must oversee the entire contracting process. Had the advertising agency’scontract with the photographer been properly written, in compliance with thecontracts between the Board and MIF, and between MIF and the advertising agency,then the Board would have owned the copyrights to the photographs.

We also question why the Board did not enforce its contract with MIF regardingproperty ownership. This contract, for the period of July 28, 1994, throughDecember 31, 1996, and renewed through December 31, 1998, states that,“Ownership of materials or assets acquired with Board funds shall be the propertyof the Secretary of Agriculture as represented by Board and MIF shall take



reasonable steps to protect that ownership.” MIF did not fulfill its contractualresponsibilities to the Board by taking the steps necessary to protect the Board’sinterest in the copyrights to the photographs. We also question why the Board’slegal counsel is not pursuing legal action against MIF because of its failure toproperly protect the Board’s interest in the copyrights.

The OGC opinion also stated that the Order does not limit the Board’s “* * * abilityto contract away any of its rights to the property that it does not own. This meansthat the government may, in its negotiations, transfer to the contractor any or all ofits patents, copyrights, inventions, trademarks and publications, if it is in thegovernment’s interest to do so.” There is no evidence of any negotiations for theownership of copyrights to the photographs.

AMS raised the issue that, had the Board wanted to own the copyright to thephotographs, there would have been an extra cost. Although we repeatedly askedfor evidence of negotiations as to the ownership of the copyrights to thephotographs, neither AMS, the Board, nor Board contractors provided suchevidence. Because of this, we do not understand how AMS can now conclude whatthe photographer would have charged if the contract had specified that the Boardwould retain ownership of the copyrights. In our opinion, the photographer owns thecopyrights to the photographs because AMS and the Board failed to meet theirresponsibility to the milk processors who fund this program.

We consulted with others in the dairy advertising industry about the costs involvedwith these photography contracts. Those officials advised that the photographycosts were very high and that, considering the unusually high cost of the professionalfees paid to this photographer, they felt that, had the Board negotiated effectively,it could have obtained ownership rights to the copyrights. We do not agree withAMS’ statement that the Board really “* * *bought what is needed to produce theadvertisement.” If it had, why did it later pay additional royalty rights totaling about$129,000?



Furthermore, the Board Administrator, under his CPA firm’s contract with the Boardto perform contract compliance audits, notified the Board Treasurer in a report datedJuly 13, 1995, that “* * *the agreement with the photographer was not signed. * * *Also, we noted that the photographs are owned by the photographer, pursuant to theterms of Section 14 of the Agreement. This provision appears to violate the termsof the Act and the Order.” This same 1995 report further states, “We were unableto determine if the agreements were reviewed/approved by the United StatesDepartment of Agriculture.” The recommendations in this 1995 report were “* * * thatthe ownership issue of the photographs be satisfactorily resolved. We recommendthat the agreement with the photographer be signed by both parties. Werecommend that the issue of USDA contract/agreement approval/review ofagreements within the subcontract between MIF and (the advertising agency) beresolved.” These issues were never addressed by AMS or the Board.

NOTE D: “The Report also claims to have found no evidence that AMS or the Boardseparately evaluated the effectiveness of its programs * * *. In this regard, it isimportant to note that the statute that requires evaluation also mandates that it be‘carried out . . . in conjunction with the evaluation of the National Dairy Promotion andResearch Board . . . .’ (Fluid Milk Promotion Act of 1990, as amended (Act), 7U.S.C. Section 6407(m)). Additionally, the Economic Research Service (ERS),which evaluates the effectiveness of the fluid milk advertising of this Board and theNational Dairy Promotion and Research Board, has stated that it is impractical tosegregate the two programs promoting fluid milk consumption. AMS provided thisletter * * * to the OIG. The Report also ignored the third-party evaluations the Boardhas initiated.”

Section H(m) of the Act states “The Secretary shall provide annually for anindependent evaluation of the effectiveness of the fluid milk promotion programcarried out under this subtitle during the previous year, in conjunction with theevaluation of the National Dairy Promotion and Research Board established undersection 113(b) of the Dairy Production Stabilization Act of 1983 * * *.” We believethis requires an independent evaluation of each dairy program and that the term “inconjunction” indicates simultaneous evaluations, not one united evaluation.



The policy of the Program, according to Section 1999B(b) of the Act, is to carry outan effective program of promotion, research, and consumer education. Unless anindependent evaluation of this program is performed, it cannot be determinedwhether the purpose of the Program has been fulfilled and the use of theassessments justified.

The memorandum dated April 15, 1998, from ERS to AMS did not use the term“impractical” in relation to separate studies of the two dairy campaigns. Rather, ERSsaid “Any current attempt to evaluate the two campaigns separately would requireadvertising variables that were unique to each campaign and based upon consumerresponses to each program. Such a model would require sampling and estimationprocedures which are beyond the time and resources of the (ERS) EvaluationCommittee.”

The AMS response stated that the Report ignored third-party evaluations the Boardhad initiated. The Board’s unsigned draft letter to AMS dated June 16, 1998,included a list of various evaluation activities/studies/research activities whichsupposedly had been performed. During our review, we asked the BoardAdministrator to provide information and copies of any evaluations or studies orsimilar type reports conducted that would determine the effectiveness of theProgram’s promotion activities. None were provided. Rather, he stated that no suchstudy had been performed and that he did not believe the Board or anyone elsewanted to know whether the Board’s activities had increased fluid milk consumption. NOTE E: “Similarly, the Report claims that the Board failed to seek bids for its website, despite the 1997 memorandum * * * the Board provided the OIG detailing itssolicitation and evaluation of bids * * *. ”

The information contained in this memorandum was not provided to us during theaudit. We have been provided two versions of the July 25, 1997, memorandumreferenced by AMS. During the audit, the advertising agency sent us the originalsigned copy of that memorandum. (See exhibit C.) That memorandum did notprovide details of the Board’s solicitations or how the Board evaluated the bids. Inits response to the official draft audit report, AMS provided us a copy of that same



memorandum. (See exhibit D.) Attachments to the memorandum provided by AMSdiffered from the attachments sent directly to OIG by the advertising agency. Wenoted that the memorandum provided by AMS was a copy of the courtesy copy sentto the Board Administrator. We have been given no explanation for the substantialdifferences in the two memorandums. It is clear, however, that there was nocompetition for this contract. The advertising agency went to its subsidiary and toldthem how much money was available and how to proceed in revising its proposal.

Neither of the memorandums referenced above, nor any other documentationprovided during the audit, contained evidence of an evaluation of the bid proposalsfor the development and maintenance of the Board’s WEB site. The documentationprovided to us indicated that the advertising agency selected four potential vendorsto bid on this project. One of the four did not respond. The other three vendors, oneof which was a wholly-owned subsidiary of the advertising agency, submittedproposals. We requested copies of the three bids and were provided copies of bidstotaling [ ], $225,000, and [ ]. The bids for [ ]were from outside vendors and were dated April 29, 1996, the due date specified inthe request for proposals. The $225,000 bid from a wholly-owned subsidiary of theadvertising agency was prepared after the due date for the bid submissions.

As stated in this report, we obtained a memorandum dated May 7, 1996, from theadvertising agency to its wholly-owned subsidiary that detailed the amount in thebudget for creating and maintaining the WEB site. (See exhibit E.) Thismemorandum stated that, “* * * we were able to position (the subsidiary) as the bestchoice for developing the Milk Web site.” It also stated, “* * * the MilkPEP boardapproved $225,000 for the design and launch of the site AND subsequent updatesthrough June 1997. Please base your revised proposal on a $225,000 budget.”Note that these instructions from the advertising agency to its subsidiary were afterthe closing date for bid submissions. This memorandum further stated, “Finally, aninternal issue: we must have your assurance that this project will be given theutmost priority in order to be up and running by the program’s official launch date* * *. In your original proposal, you noted that you could not make that timing. * * *Please let me know when we can expect to receive your revised proposal to forwardto (MIF).” OIG asked for, but never received, the original bid proposal. In our



opinion, acceptance of the revised bid proposal from the subsidiary is a clearviolation of competitive bidding practices.

It is clear that there was no meaningful competition for the development andmaintenance of the Board’s WEB site. The advertising agency assured that itssubsidiary would be selected as the contractor by providing insider information to itssubsidiary and accepting the bid proposal after the due date.

NOTE F: “ * * * the Report’s discussion of sole-source contracting seems to assumethat the Federal Acquisition Regulations apply to promotion programs. In responseto our inquiry on the subject, OGC has provided a legal opinion * * * stating that asa matter of law, promotion programs are not bound by these restrictions. This OGCopinion was made available to OIG.”

We did not recommend that the Board comply with the Federal AcquisitionRegulations. We first received the OGC opinion, dated June 18, 1998, as anattachment to AMS’ response to us dated July 24, 1998. This OGC opinion statesthat, “The OIG draft report * * * makes no implication that Federal procurement lawsapply to the Board. * * * The draft report addresses the wisdom of the Board’sbusiness practices and Government oversight of those practices.” This same OGCopinion further states, “* * * the Secretary has an oversight responsibility forcontracts entered into by the Board. The Secretary could use this oversight role toapply the policies underlying these Federal statutes and regulations to the Board’scontracting process.”

Again, we did not state that the Federal Acquisition Regulations apply to thisProgram. We continue to recommend that AMS require the Board to discontinueawarding sole-source contracts and subcontracts and establish guidelines forawarding contracts to ensure that competition is sought and that contracted goodsand services are obtained in the most cost effective manner.

NOTE G: “AMS’ changes to its oversight of the Board combined with its repeatedattempts to correct the Report’s misstatements demonstrates the Agency’s



commitment to strong oversight and an accurate, dispassionate review of AMSactivities. * * * However, by ignoring changes that have occurred since the issuanceof the Alert, by misstating legal and factual issues, and by extrapolating fromunsupported assertions, the draft Report paints an inaccurate portrait of the Boardas well as of AMS’ oversight.”

We have acknowledged changes made since the issuance of the Management Alert.Contrary to AMS’ statements, we did not misstate legal or factual issues. AMSmade these statements but did not provide support for them. Our report, supportedby all the evidence we gathered, accurately reflects the Board’s operations andAMS’ oversight.

NOTE H: “We agree that the Fluid Milk Promotion Act of 1990, as amended (Act),requires an independent evaluation of the effectiveness of the fluid milk promotionprogram, but we disagree that this is not currently done. In making thisrecommendation, the Report misconstrues the law and the opinion of the ERS * * *.First, despite the Report’s criticism, the statute mandates that this evaluation occurin conjunction with the evaluation of the producer funded dairy promotion program.Second, it is the opinion of ERS which (1) has experience in evaluating advertisingand promotion programs, (2) has knowledge of the econometric models and dataavailable to evaluate advertising programs, and (3) has evaluated dairy advertisingprograms since 1988, that it is not practical (given current resources) to evaluateseparately the effects of the two programs.

“In sum, since the inception of generic dairy advertising under the producer fundeddairy promotion program and fluid milk advertising under the Fluid Milk Program,generic advertising for fluid milk and dairy products has been the subject of annualindependent evaluations * * *.”

Section H(m) of the Act states “The Secretary shall provide annually for anindependent evaluation of the effectiveness of the fluid milk promotion programcarried out under this subtitle during the previous year, in conjunction with theevaluation of the National Dairy Promotion and Research Board established under



section 113(b) of the Dairy Production Stabilization Act of 1983 * * *.” We believethis requires an independent evaluation of each dairy program and that the term “inconjunction” indicates simultaneous evaluations, not one united evaluation.

The policy of the Program, according to Section 1999B(b) of the Act, is to carry outan effective program of promotion, research, and consumer education. Unless anindependent evaluation of this program is performed, it cannot be determinedwhether the purpose of the Program has been fulfilled and the use of theassessments justified.

The memorandum dated April 15, 1998, from ERS to AMS did not use the term“impractical” in relation to separate studies of the two dairy campaigns. Rather, ERSsaid “Any current attempt to evaluate the two campaigns separately would requireadvertising variables that were unique to each campaign and based upon consumerresponses to each program. Such a model would require sampling and estimationprocedures which are beyond the time and resources of the (ERS) EvaluationCommittee.”

The AMS response stated that the Report ignored third-party evaluations the Boardhad initiated. The Board’s unsigned draft letter to AMS dated June 16, 1998,included a list of various evaluation activities/studies/research activities whichsupposedly had been performed. During our review, we asked the BoardAdministrator to provide information and copies of any evaluations or studies orsimilar type reports conducted that would determine the effectiveness of theProgram’s promotion activities. None were provided. Rather, he stated that no suchstudy had been performed and that he did not believe the Board or anyone elsewanted to know whether the Board’s activities had increased fluid milk consumption. NOTE I: “Since the OIG audit ended shortly after the issuance of the Alert, theReport does not reveal the extensive changes made to the contract approvalprocess.

“The review and approval of Board budgets, program plans, and project descriptionsby AMS lays the framework for the program and administrative expenditures. The



contract approval process further formalizes the budgetary process to implement theapproved campaigns and projects of the Board. Contracts in which the Board is aparty now are submitted to AMS for review and approval prior to the contractbecoming effective. Such contracts state that the agreement shall become effectiveupon the approval by USDA. Subcontracts, MIF/IDFA contracts for resources, asidentified in the September 17, 1997, approval process, are sent to AMS forapproval.”

We did not end our review 1 month after we issued our Management Alert. Ouraudit covered the period December 1993 through June 1997; however, our fieldworkcontinued for several more months. We have recognized changes AMS hasreportedly made to the contracting process which we reported as unverified.

We do not agree that AMS’ approval of the Board’s budget can be substituted forcontract review and approval. Budgets are general outlines of planned programexpenditures. Budget review and approval can, in no way, substitute for contractreview and approval. Each contract, subcontract, sub-subcontract, etc., must bemade available for AMS’ scrutiny, review, and approval.

We also acknowledged that a new contract review process had been implemented;however, with the information provided, we were unable to fully assess what thereview process is. For example, in response to our Management Alert, AMS agreedon May 19, 1997, to “ * * * require that the Board submit all contracts andsubcontracts to the Department for review.” AMS revised its policy again onSeptember 17, 1997, which included a review and approval of about 9 contracts. Inits July 24, 1998, response to our official draft report, AMS stated that it “* * *willrevise its September 17, 1997, contract approval process with the Board to requirethat, in addition to all Board contracts, all contracts of the Board’s contractors bereviewed and approved by AMS.” We agreed with the changes AMS made inresponse to our Management Alert; however, we did not agree with the changesmade on September 17, 1997. We also disagree with the proposed revision, asstated in AMS’ July 24, 1998, memorandum, because it does not include allcontracts, subcontracts, sub-subcontracts, etc., which obligate Program funds.



Note J: “To reach below those subcontracts and approve contracts ofsubcontractors, would require the submission and approval of approximately 3,000sub-subcontracts, sub-sub-subcontracts and purchase orders per year. Arequirement that all of these contracts be submitted to AMS for review and approvalprior to the activity would so hamper the implementation of the program that it wouldbe unable to function.”

We have never recommended that purchase orders be submitted for AMS’ reviewand approval. However, we still believe that all contracts, subcontracts, sub-subcontracts, etc., must be submitted to AMS and that AMS must develop thecriteria and threshold for determining which of these contracts will require a formalreview and approval. AMS’ discussion of “3,000 sub-subcontracts, sub-sub-subcontracts and purchase orders” is irrelevant and does not address any issue inthis report. The preponderance of the 3,000 figure is purchase orders.

NOTE K: “AMS--and OGC--disagree with the Report’s interpretation of the legalmandates. We disagree with the assertion by OIG that the Board has inappropriatelyhandled the ownership of the photographs prepared for the program. Even thoughthe OGC opinion was provided to OIG well in advance of releasing the Report, OIGhas chosen to disregard it.”

AMS has not provided us a copy of OGC’s disagreement with anything in this report;consequently, we cannot comment on any such disagreement. We are not“asserting” that the Board has inappropriately handled the ownership of thephotographs prepared for the Program. In Finding No. 3 we stated that both AMSand the Board failed to meet their responsibility for oversight of the contracts with thephotographer. Lack of proper oversight by both AMS and the Board is evidenced by:Failure to execute contracts with the photographer, failure to document negotiations(if any negotiations were actually conducted) for the copyrights to the photographs,and failure to obtain AMS’ approval.

We did not disregard OGC’s opinion. It is evident that the opinion says that, as thecontract was written, the photographer owns the copyrights to the photographs.



There is no evidence of any negotiations for the ownership of copyrights to thephotographs.

The February 10, 1998, OGC opinion states that “ * * * the agreement with (thephotographer) did not expressly provide that the photographs would be considereda ‘work made for hire.’ If (the photographer) and the Board (through its advertisingagency), had expressly provided that the photographs were to be ‘work made forhire,’ then the copyright to them would not automatically belong to (thephotographer).” If the photographer and the Board (through MIF and the advertisingagency) had expressly agreed that the Board would own the copyright to thephotographs, the Board would not have had to pay the additional royalty rightstotaling $129,000 for the use of the photographs. This is a classic example of whyAMS must oversee the entire contracting process. Had the advertising agency’scontract with the photographer been properly written, in compliance with thecontracts between the Board and MIF, and between MIF and the advertising agency,then the Board would have owned the copyrights to the photographs.

NOTE L: “The report attempts to exchange ‘assets’ for the carefully crafted languageof the law. Immediately after citing the Order language quoted above, the Reportstates that ‘according to the provisions in the Order, the Board is required to take titleto all assets developed or acquired with Board funds.’ (Emphasis added.) Clearly,the term ‘asset’ expands the regulatory language.”

We agree that the term “asset” can be used to define a broad range of property.However, in no instance did we refer to any asset other than the copyrights to thephotographs. Also, the value of copyrights is always listed on the balance sheet asan asset. We did not err in our use of the word “asset.”

NOTE M: “While the Report claims that the Order requires the Board to do so, suchphotographs are neither patents, copyrights, trademarks, inventions, or publications.OGC has issued an opinion on this issue, yet the Report ignores this finding * * *.”

We did not ignore the OGC opinion. We have never said that photographs are



copyrights. However, the photographs are copyrighted items and, because of theway the contract was written, the photographer owns the copyrights to thephotographs. As a result, the photographer, and not the Board, controls the use ofthe photographs. Our concern all along has been who has control and use of thephotographs. Without owning the copyright, the Board can use the photographs onlywith the permission of the copyright owner and must pay additional royalties foradditional uses.

NOTE N: “Almost all contracts submitted by the Board contain standard languagethat has been reviewed by the OGC for legal sufficiency.”

We recognized in our report that the contract language had been reviewed by OGC.However, the larger issue is not “legal sufficiency,” but that AMS should ensure thatall contracts adequately address requirements in the Act and the Order.

NOTE O: “The Board owns the copyrights to the ads which incorporated the selectedphotographs. Because the Board received what it paid for--no more, no less--it hascomplied with the Act and Order * * *.”

We recognize that the Board owns the copyright to the advertisements; however, theBoard does not own the copyrights to the photographs in those advertisements. Thecontracts with the photographer only allowed the Board to use the photographs in theadvertisements for 15 months, with renewal options available at additional cost. Asa result, ownership of the copyrights to the advertisements is of limited valuebecause the photograph is the focal point of those advertisements.

NOTE P: “ * * * the Report fails to recognize actions taken to implement thisrecommendation * * *, which also was part of the Alert issued more than a year ago.

“In the future, AMS also will require that the Board’s Chairman and Administratorboth sign the management representation letters to CPA firms regarding the Board’sfinancial, contractual, and legal position. In addition, AMS will request copies of suchletters for review.”



The issue regarding management representation letters was not included in ourManagement Alert. Our first recommendation regarding management representationletters was in our draft audit report. The first time we were made aware of anycorrective actions taken regarding management representation letters was in AMS’response dated July 24, 1998, to our official draft report.

We agree that the Board’s Chairman and Administrator should both sign themanagement representation letters to CPA firms and that AMS should obtain copiesof these letters. However, AMS must also provide assurance that the Board’smanagement representation letters accurately reflect the position of the Board’sfinancial, contractual, and legal position.

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EXHIBIT C - ADVERTISING AGENCY’S MEMORANDUM TO OIG























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EXHIBIT D - ADVERTISING AGENCY’S MEMORANDUM TO OIG AS SENT BY AMS













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EXHIBIT E - ADVERTISING AGENCY’S MEMORANDUM TO ITS SUBSIDIARY

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EXHIBIT E - ADVERTISING AGENCY’S MEMORANDUM TO ITS SUBSIDIARY

Documents

U. S. Department of Agriculture Office of Inspector ... · 01001-3-Ch SEPTEMBER 1998 ` U. S. Department of Agriculture Office of Inspector General Audit Report National Fluid Milk