Defence Force personnel involvement with a commercial entity - Miltech

File Ref: EN/GVT-0032

Hon Gerry Brownlee
Minister of Defence
Parliament Buildings
Wellington 6160

Dear Minister

DEFENCE FORCE PERSONNEL INVOLVEMENT WITH A COMMERCIAL ENTITY - MILTECH

Your predecessor as Minister of Defence, Hon Dr Jonathan Coleman, asked me on 16 June 2014 to look into a procurement arrangement involving the New Zealand Defence Force (NZDF) and Miltech Limited (Miltech), a commercial business servicing life jackets for NZDF.

The Minister asked because Miltech was then owned and operated by a serving member (Person A) of the Royal New Zealand Air Force (the Air Force), and two other serving members of the Air Force were involved in other companies related to Miltech.

In February 2014, NZDF’s Naval Supply Depot had entered into a short-term contract with Miltech to service and maintain lifejackets for the Royal New Zealand Navy. This was an interim arrangement to ensure that lifejackets would be supplied until NZDF could call for tenders for NZDF-wide life jacket servicing. In June 2014, NZDF evaluated the tenders.

In his letter, the Minister asked whether I would:

• confirm whether any illegal or inappropriate activity had occurred;
• provide confidence that NZDF has appropriate and effective systems to recognise and manage any conflicts of interest; and
• identify where any improvements could be made in NZDF and the Government to prevent similar situations occurring.

The Minister told me that NZDF was carrying out its own investigation into the matter. In the following months, my staff raised some questions and sought more details after NZDF’s first internal investigation. During the following year, NZDF commissioned several more investigations or reviews, including:

1. an internal investigation into the award of the interim life jacket support contract (by NZDF's Director of Risk and Assurance);
2. internal and external reviews of the Director of Risk and Assurance’s investigation and findings report (by NZDF Provost Marshal and Deloitte);
3. internal investigations into management responsibility and accountability for the initial interim life jacket support contract, conflicts of interest, and knowledge of secondary employment by NZDF personnel (by NZDF);
4. disciplinary investigation into whether there was any continuing association between serving members of the NZDF and the Miltech group of companies (by NZDF Provost Marshal); and
5. external procurement review of the interim and long-term life jacket contracts (by Deloitte).

We did not want our work to duplicate or interfere with NZDF’s investigations. We waited for the findings of those investigations before reporting our own findings and conclusions. The completion of the NZDF-initiated investigations and further information received in recent months from NZDF and other parties have enabled us to conclude our investigation. We have considered the findings of those reviews as part of our work.

Based on the Minister’s request and the NZDF investigations, we decided to consider five questions:

1. Was there any illegal activity involved?
2. Did NZDF’s arrangement with Miltech breach NZDF’s rules on secondary employment?
3. Did NZDF’s arrangement with Miltech breach public sector procurement requirements or good practice principles?
4. Was any of the activity relating to the arrangement inappropriate or questionable in terms of ethical behaviour (that is, did it raise any probity concerns)?
5. Does NZDF have appropriate policies and systems in place to identify and manage situations where there might be a risk of violating policies, rules, or good practice in its procurement arrangements?

This letter sets out the views we have formed as a result of the work we carried out. The attachment sets out what happened, and our expectations and findings on the procurement and secondary employment matters, in more detail.

What we did

The main focus of our inquiry was the interim life jacket support contract that NZDF and Miltech entered into in February 2014 (the “interim arrangement”). The interim arrangement was worth $114,000, a relatively small sum of money compared with NZDF's annual spending of about $3 billion.

We have examined documents provided by NZDF (including the reports from NZDF’s investigations and notes from interviews conducted by NZDF’s Director of Risk and Assurance), Miltech, and SOS Marine (the Australian company that manufactures and supplies SOS Marine life jackets to the Royal New Zealand Navy). We have also held interviews and discussions with some NZDF personnel and with individuals involved with Miltech and SOS Marine. We have sought explanations on various matters from senior personnel within NZDF.

It has taken us longer than initially expected to get enough clarity on some matters to conclude our inquiry. We could have continued and examined a more extensive range of documents and interviewed more personnel, but we do not consider that any further enquiries would significantly affect our findings. We consider that we now have enough information to reach a view on this matter.

Summary of findings and conclusions

1	Was there any illegal activity involved?
	We found no evidence of illegal activity in the interim arrangement between NZDF and Miltech for life jacket servicing.
2	Did NZDF’s arrangement with Miltech breach NZDF’s rules on secondary employment?
	Yes. The interim arrangement between NZDF and Miltech, entered into in February 2014, did not comply with NZDF rules about secondary employment because of Person A’s close involvement with Miltech at that time. This situation continued until June 2014, when Person A relinquished his interest in Miltech after concerns were raised in Parliament. From June 2014, the arrangement complied with the secondary employment rules because Person A was no longer involved. NZDF’s rules on secondary employment, including approval requirements, are designed to manage the risks associated with secondary employment. Applying the rules properly should ensure that secondary employment activities do not interfere with service duties, nor create a perception that a serving person is using their position as a member of the NZDF to further their private interests. The rules prohibit involvement by a serving person in any transaction between their private business and the NZDF. Had the rules been properly applied, the arrangement between NZDF and Miltech would not have happened. It is not clear to us that Person A or Air Force command properly considered or applied the rules about secondary employment at relevant times. Air Force command supported Person A’s proposal in 2013 that Miltech could provide a possible solution to meeting the Navy’s life jacket servicing demand. The proposed solution was beneficial to both NZDF and Person A in a private capacity, and the arrangement achieved a positive outcome for NZDF in circumstances of some urgency. However, by supporting the proposal and initially permitting Person A’s involvement in the ensuing interim arrangement servicing work, Air Force command failed to apply NZDF’s rules about secondary employment.
3	Did NZDF’s arrangement with Miltech breach public sector procurement requirements or good practice principles?
	Yes. The interim arrangement with Miltech did not meet NZDF or public sector procurement requirements or good practice principles because: The Naval Supply Depot’s process to appoint Miltech for this work was hurried and there was minimal testing of the market for providers. The Naval Supply Depot’s process for awarding work under the interim arrangement was informal and undocumented. It is not apparent the approving officer was aware that serving officers were involved with the Miltech companies. The arrangement between NZDF and Miltech lacked transparency and the evidence needed to demonstrate a fair process and a justifiable decision. NZDF failed to identify and manage the risk of real or perceived unfairness in awarding the work under the interim arrangement to Miltech. In our view, the procurement process was inadequate, not enough attention was given to the range of risks and, because of the involvement of NZDF personnel in the vendor company, the decision was inappropriate.
4	Was any of the activity relating to the arrangement inappropriate or questionable in terms of ethical behaviour (that is, did it raise any probity concerns)?
	The arrangement did not meet the standards expected in the public sector. Public sector procurement processes must be robust enough to minimise the risk, real or perceived, that employees might be able to obtain private business benefits because of knowledge or connections arising out of their publicly funded employment. For the reasons noted above, that was not the case here. In our view, although those involved acted in good faith, their behaviour and activities raise ethical and probity concerns about fairness and transparency.
5	Does NZDF have appropriate policies and systems in place to identify and manage situations where there might be a risk of violating policies, rules, or good practice in its procurement arrangements?
	We have not carried out a comprehensive review of NZDF’s systems for procurement. NZDF has well-established rules about secondary employment, but the fact that they were not met or applied in this instance indicates a lack of awareness of them on the part of some personnel. We have not reviewed how the rules have been applied in other situations, so can offer no broad assurance about NZDF’s overall systems for managing these matters.

Overall, a poorly managed process for a relatively small-value procurement has resulted in several investigations and reviews, which are disproportionate to the amount of public money spent on the life jacket servicing work. This could have been avoided if:

• processes were formalised, documented, and matters reported in a transparent and timely manner;
• the Air Force’s own Defence Force Order on secondary employment had been followed; and
• the principles of good procurement were applied from the outset.

NZDF has accepted that the procurement process was defective. NZDF concedes that the way it handled matters with its personnel was neither timely nor thorough. Whether similar events will be prevented from happening in the future will depend on the consistent application of NZDF’s Defence Force Orders regulating secondary employment for serving personnel and the consistent application of procurement processes.

I have two recommendations for NZDF. Since my draft recommendations were conveyed to NZDF, it told us that it has conducted familiarisation briefings for all personnel involved in procurement. The briefings covered the Government Rules of Sourcing and managing conflicts of interest.

Recommendations

I recommend that the New Zealand Defence Force:

1. ensure that personnel involved in contracting decisions are familiar with, and able to apply, the principles of good procurement and are trained in potential areas of risks to good procurement practice;
2. review its approach to documenting and managing secondary employment situations; including:
   • regularly reminding all personnel about the existence and content of Defence Force Orders for secondary employment;
   • considering systems for ensuring that commanding officers apply those Orders;
   • ensuring that:
     • all serving personnel engaging in permissible secondary employment are identified and have received formal command approval;
     • any further instances of serving personnel carrying out work in a private capacity for New Zealand Defence Force are identified and the arrangements ended; and
     • any further instances of service personnel engaging in private business activities that may create a perception that they can use their position in New Zealand Defence Force to further their private interests are identified and appropriately addressed.

Because of the level of interest in this matter, I have decided to publish this letter on my Office’s website.

Yours faithfully,

Lyn Provost
Controller and Auditor-General

cc
Hon Dr Jonathan Coleman
Lt Gen Tim Keating, Chief of Defence Force