EVIDENCE

STANDING COMMITTEE ON PUBLIC ACCOUNTS

WEDNESDAY

11 OCTOBER 2000

REPORT OF THE AUDITOR-GENERAL FOR THE YEAR ENDED 31 MARCH 1999, VOTE 11, [RP 134/1999]

SPECIAL REPORT OF THE AUDITOR-GENERAL ON THE STOCK HOLDINGS IN THE DEPARTMENT OF DEFENCE,  [RP 33/2000]

CHAIRPERSON] There are three Reports from the Auditor-General which will form the basis of the enquiries that the Committee will conduct today. We will look at issues arising from these Reports in a particular sequence. We will begin with some long outstanding issues that come from the Auditor-General’s Reports going back a few years, including the Annual Report for the year ending March 1999. We will then move onto a Special Report conducted by the Auditor-General in the middle of last year where he had eluded to the issue of excessive stocks in the SANDF. Then we will move to the most recent Report, which is the Special Report on the investigation of the selection process of the strategic Defence packages for the acquisition of armaments of the Department of Defence. We will then engage on issues arising from the third Report where there are a number of issues we wish to discuss. A particular feature of our Hearing today are the considerable sums of money which the Committee wants to look at and our mandate is mainly about the state’s financial interest. With respect to these large sums of money this becomes a very important Hearing for the Committee. The first issue we will start with are issues of unauthorized expenditure.

Mr L Chiba] I am going to deal with the issue of unauthorized expenditure and that is in connection with your appointment of Defence Review consultants. There were three issues there. Payments to these consultants were made. They were appointed without obtaining State Tender Board Approval before or after the appointments and hence the unauthorized expenditure. Although the total amounts for the three years amount to less than R1 million, what is important here is the principle, namely, very strict adherence to rules and regulations and procedures. The matter has been outstanding for three years and SCOPA cannot afford the luxury of having it as outstanding business year after year. The matter needs to be finalized one way or the other and the appropriate recommendation made to Parliament. I would like to make one or two observations and pose one or two questions. You may choose to respond briefly here or you may choose to respond in writing after you have considered the matter very carefully. The first issue I would like to touch upon is the issue of time constraints. The impression seems to be created that because of time constraints the Department of Defence by-passed the requirements of the State Tender Board and therefore neither opted for the open or the closed tender. I would like to make the observation, on behalf of the Committee, that any suggestion that the Department did not have enough time is actually incorrect. It is the view of this Committee that there was ample time for the Department of Defence to pursue and explore the possibility of an open or closed tender process. The second issue that I would like to touch upon is the question of the shortlist. In his final answer, dated the 4^th of May, the previous Secretary of Defence stated and I quote “The Department of Defence acknowledges that the shorter tender process would be the option to pursue. However, it could not be done, because the consultants were individually identified by me and no shortlist was compiled. I want to stress that “no shortlist was compiled”. However, on the 25^th of March, the Minister of Defence himself stated something else. What he said was this “after wide consultations a shortlist was drawn up of suitable persons with the necessary skills, qualifications, military knowledge and creditability to guarantee an acceptable product’. If you look at the two statements, I find a contradiction here. On the one hand, the previous Secretary of Defence stated there was no shortlist. On the other hand, the Minister of Defence says a shortlist was drawn up. The statement you gave contradicts the statement of the Minister of Defence. By when can the Department clarify this issue for this Committee? We, as a Committee, are not in position to determine which is the exact and true statement. – [Mr J L Grundling] As far as the issues of time constraints are concerned, the Department has said that the time was too short in order to go through the full tender procedure. We have conceded that in retrospect it would have been possible to follow a closed tender procedure. Secondly, as far as the shortlist is concerned, it is possible that the Minister and the Deputy-Minister could have been consulting since this was Defence policy and political in nature in setting up the Defence policy, that they could have been consulting with other stakeholders about who could be considered and who they would have in their shortlist without the Department knowing about this. The information that I have, although I did not participate personally in this, was that when the political level discussed this with the Administration, that there was already an identified list of persons that the Minister’s preferred to use for this process. It is from that list that the Department went ahead and contracted these people and started to employ them. What I am saying is that the Department, itself, did not participate in the process of considering candidates and short listing. My understanding is that that was a short list that was given through to the Department to contract these people and start to employ them for this process. – [Mr L Chiba] Are you then trying to convey to this Committee that the one arm of the Defence Department did not know what the other arm of the Defence Department was doing? – [Mr J L Grundling] There are things that Ministers do that officials are not aware of. They are not involved in that process, which is their domain. And after those considerations have taken place, direction is given through from there to the Department. I do not think it is a question of one not knowing what the other one does. The one operates in each domain with each prerogative and the Department is under the direction control of the Ministers when they have considered at their level their business. That is direction that comes through to the Department.

Mr L Chiba] The third aspect that I would like to touch upon is the question of skills, qualification and expertise. Now according to the Auditor-General’s Report on paragraph 45 of the Report for 1998, the following appears. ”According to the Department it would have been more expensive to contract new consultants for the 1997/1998 year as the eight  consultants concerned had already gone through a learning curve”. I would like to stress that “they had already gone through a learning curve’. However, in addition to the above, the Minister stated the following in his letter to SCOPA on the 25^th of March 1999. ‘After wide consultation a shortlist was drawn up of suitable persons with the necessary skills, qualifications, military knowledge and creditability to guarantee an acceptable product”. The issue that arises is the following, the eight consultants who are appointed in the 1997/1998 financial year, on the basis that they had gone through a learning curve, but during the previous year, they had been appointed on the basis of their suitability, skills, qualifications etc. We find that there is something fundamentally wrong here. Why should they go through a learning curve if they were sufficiently suitably skilled, qualified and knowledgeable and if they had gone through a learning curve, then they were not suitable, not skilled, not knowledgeable and qualified as the Department claims. The view of SCOPA is that their appointments in 1996/1997 on the basis of the skills are questionable. Would you like to offer a comment on our observation? – [Mr T Motumi] My name is Tsepo Motumi. I am the Head of Planning in the Defence Department. With respect to that question, yes, their selection was according to the dates to have been suitable, primarily arising out of the knowledge and expertise that they held in their respective jobs and it was on that basis that the Ministry decided to select them to do the job. – [Mr L Chiba] On the one hand they have been appointed on the grounds that they had gone through a learning curve, if that is so, then why were they firstly appointed on the basis of their qualifications as declared? This is the contradiction that this Committee finds. I do not find your answer acceptable to this Committee. – [Mr J L Grundling] I think it is possible that before the process starts, that the Minister can consider who is knowledgeable in this area, who is skilled in this type of policy evaluation and development and particularly with the background as far as Defence is concerned and select a number of people on that basis. However, the process of consulting the nation, as far as Defence policy is concerned, is something else. The work that was done during this review involved various consultation sessions throughout the country working with the constituencies, as well as within government and Parliament. It is possible that this group of people, including these consultants as well as officials, went through a learning curve regarding the process of forming a policy based on a very wide consultative process. It is therefore possible, in the second year, that those consultants that had originally been employed for their recognized skills and knowledge, as far as Defence policy is concerned, had learned in that year the process of forming policy on a widely consultative basis and therefore were employed in the second and the third year. In my mind this does not constitute a contradiction.

Mr L Chiba] We will let it pass. I come to the fourth issue of non-compliance. In his letter the Chief: Finance wrote to the Defence Secretary and stated the following and I quote “It is patently obvious that the motivation with the appointment of the persons listed in your letter does not comply with the requirements of Treasury Instruction ST3 and the State Tender Board Regulations.” And in terms of the minutes of the Council of Defence on the 5^th of June 1998, the following has been said and I quote “There are rules and regulations that have been followed. Decisions, the rules and regulations pertaining to the appointment of the advisors must be adhered to.” Firstly, it is evident that the appointment of the Defence Review Consultants would incur unauthorized expenditure. They went on and made the appointments in the full knowledge that that will happen. Secondly, that the advise of the Chief of Staff : Finance was not considered under any circumstances. Thirdly, the decision of the meeting of the Council of Defence was not implemented. We are of the view that there was an element of deliberateness in ignoring this particular decision. I do not think you ought to make a comment on that. If you do not wish to, I would like to touch upon the last aspect of my contribution. – [Mr J L Grundling] It is true that there was tension within the Department, both between the Administration and the Executive, as well as between functions within the Department regarding the procurement of this particular service. I think that the position of the Finance Division was very clear. We did not wish to provide a financial authority for this commitment since it was patently incorrect to do so. However, the fact of the matter is that the process was initiated. The people had been contacted and they started their work. The Defence was receiving the service before the contracting could be completed or even the question of the financial authority issued in this case. So, it was the question of the Executive, as well as particular branches of our Department’s Administration that simply went ahead with the process without there being a financial authority in position. That is true exactly as the member has stated.

Mr L Chiba] I come to the last issue of ex post facto approval. In our Hearing of the 29^th of June that issue was touched upon. Has ex post facto approval now been applied for in relation to each of the three appointments of the Defence Review Consultants? If so, what has been the response of the Department of State Expenditure to your application for approval? And if not, what are the reasons for not applying for ex post facto approval and by when shall this be done? Notwithstanding the fact that payments to the consultants have been reported as unauthorized expenditure for the last three years, why does the Department of Defence continue with the practice of appointing consultants without the necessary State Tender Board approval? – [Mr J L Grundling] Unfortunately our written response to our previous appearance before you was only delivered yesterday.  In that correspondence we have indicated that we have subsequently gone to the State Tender Board to ask for post factum approval of this for the three years in question. The answer was no, they would not approve it and that is exactly what we had anticipated. That is the underlying reason why the Department had not in the three previous years gone to the State Tender Board, because they do not grant approval post factum for something that is irregular. However, we have gone through the drill and the answer is that it is not being approved. – [Mr L Chiba] What I do want to say there is that the fact that you suspected the State Tender Board will not grant you approval for that does not mean that you should not apply for ex post facto approval. By that you are further violating the regulations. I would like to have a response to the fourth question I posed about the habit of the practice of the Department of Defence to continuing employing consultants without the State Tender Board approval. – [Mr J L Grundling] Unfortunately, that is a fact. There is the Auditor-General’s evidence of this taking place in the Department. At our last appearance we did recognize and acknowledge that that is a weakness as far as procurement in our Department is concerned, not only to do with consultants, but for goods and services as well. There are a number of events and that clearly points out the weakness within Defence as far as procurement is concerned. In our response to you, which was delivered, we have indicated to you the wide-ranging measures that we have taken inside the Department in order to get this under control. It basically goes about setting up very clear prescripts in this regard. It goes about appointing dedicated officials for procurement purposes. It goes about the training of these people and to that we are now adding with the appointment of the Chief Finance Officer to assist the Accounting Officer stringent measures during the course of the year to hold to account members that are properly appointed and trained for that proper prescripts that make themselves guilty of this to prosecute them in terms of the PFMA (Public Finance Management Act). We have provided an explanation of what are the actions that we are going to be taking. Unfortunately, when we appear in front of you in this year for our 1999/2000 year there are going to be events shown by the Auditor-General, but we do believe that with these measures that we have explained to you in writing, and as I have pointed out to you now, that we can arrest this tendency in our Department. – [Mr L Chiba] I would just want to say one thing that if this practice continues, then of course you leave the Public Accounts Committee with no alternative but to refuse to recommend authorization to unauthorized expenditure. You have heard what the Committee has said and if you wish to make further representations, motivating approval for the unauthorized expenditure, please do so in writing and ensure that that response reaches us the latest by Tuesday next week.

Chairperson] Just to refer to your earlier questions concerning that the one arm does not know what the other arm is doing and the answer which explained the position of the Minister, we would draw your attention in the new financial management era of the new Act, Section 64, regarding Executive Directors having financial implications and the procedures to be followed. Let us move onto our next issue. This concerns the Medical Stock Trading Account.

Ms N Hlangwana] During the 1997/1998 financial year a difference between the two systems of R6 million was recorded. I am speaking on page 30 of the Auditor-General’s Report, paragraph 2.2.2. It was recorded in the balance sheet of the Trading Account for Medical Stock that during the 1998/1999 financial year a difference of R1 million was written off in the income statement and in the 1999/2000 a further R5 million was written off in the same manner. With regard to the future existence of the Trading Account for Medical Stock and the other Committee’s previous concerns in this regard, what is the Department of Defence’s view on finally closing down terms and by when will that be done? – [Mr J B Masilela] Yes, we have seriously looked into the matter and we have drawn serious lessons and the conclusion we have arrived at, as the Department of Defence, is that we must close down this account. Then in terms of the time frame, we are working on this. It should be as soon as possible. – [Ms N Hlangwana] As soon as possible? I do not know how soon is as soon as possible. – [Mr J B Masilela] As soon as our Chief of Finance has delivered the details of the timeframes. – [Mr J L Grundling] The turnover on this account has come down in the last three years. The number of clients using it is reduced and the losses are not under control. What we understand from this is that the PFMA leaves the discretion with us to close it and not the Commission of Treasury to do so. At this stage the provinces no longer use this service. It is only the Police and Correctional Services. We tried very hard by this appearance to get, not approval, but acceptance by these two departments that that service would be terminated. We were unable to do so. Within the next week or two and after that we will be able to set a date on which we would like to close it. We have, unfortunately, accumulated losses of about R9 million that we are going to have to try and accommodate in this financial year or perhaps spread it over two years. If you would please give us the permission to, I would say within three weeks, to give you written feedback as to the date on which we practically can get it closed. We also need, in this case, to consult with National Treasury regarding the assets and how one should get to distribute these assets as a consequence of the closing. – [Ms N Hlangwana] Seeing that you have given me that there are only two departments that are still being serviced by these terms, will this practice, when you close down of supplying other parties with medical stock seize as well? Are you giving notice to these two departments or are you requesting them to accept that you have to close or are you telling them that you have to close? There is a difference between the two. – [Mr J L Grundling] The way in which we have gone to these two departments is to indicate that Defence is no longer in a position to supply such a service and whether the consequences of such a decision could be managed by themselves. That is the answer that we are waiting for. We have told them that we really wish to close and it goes more about managing the consequences of that than us being dependent on them. We would have to give them time to arrange for the alternative if they are too adversely affected by this. That is why we are not able to give that answer today.  – [Ms N Hlangwana] I think what needed to happen because of this problem having dragged for so long was that a decision should have been taken to say to these two departments that by this date, because we are also suffering losses as a department, we as the Department of Defence would be closing. So between that period and this period they would have to make alternative arrangements, because when you wait for them to respond you are waiting for them to take their own time whilst they are benefiting and you are coming here to account for their audits. We will wait for the report in three-week’s time and by that time we should also receive a letter that indicates that these are the dates that you have indicated to them that you will be closing down.

Chairperson] Our next item is that Special Report on the investigation into stockholdings of the Department of Defence which the Auditor-General released just over a year ago. For a number of years SCOPA has raised concerns with the Department on matters relating to these stockholdings. And our main questions would be whether these huge amounts of stocks are adequately controlled? Is the level of stocks not excessive? As an Oversight Committee, our approach is that stock is essentially money. Are we doing justice to taxpayers’ money? Are we spending taxpayer’s money in the way they intend when we buy stock, especially when we buy excessive stocks and especially when we do not control those stocks. Of course, when there are excessive stocks and they are not controlled well and stocks go missing and due to be in excess, they ultimately get written off as absolute and there are consequences on the delivery side from government. We might simplify it by saying for each uniform that sits on a shelf for a few years and it then gets disposed of, we perhaps denied some child medical care. And with that approach issues of stock are very important to this Committee. I think after a few years of pursuing these questions and not getting satisfactory answers, we recommended, through Parliament, that an investigation does take place which resulted in this Auditor-General’s investigation which as he says in the scope of the audit was limited in many respects, but it certainly went far enough to confirm the deep concerns that the Committee have had. I think what points to this, perhaps more than anything, is that the Report suggests that regarding the Army, stockholdings were amounted to 4.6 years of stock and the Air Force 1.4 years and the Navy 5 years. We do understand that the natures of stocks across the SANDF are not the same as Pick ‘n Pay who have two days stockholding, but still 4.6 and 5 years are questionably excessive. I would not be exaggerating to say this translates into as much as R20 billion of state’s money that is being denied from the fiscus that you are keeping on your shelves and which are at risk in two ways. And of course R20 billion would amount to more than the entire Health and Education budget for a year. It would amount to two years of the Defence budget. We have heard some responses from yourself as to progress made around these recommendations. To be honest, we are not at all satisfied with the progress you tell us you have made. Too many of the points of recommendation, you are simply saying what you are going to do and not too much of what you actually have done. I think this is borne out by an investigation of which we have had sight of done by PriceWaterhouseCooper, which will be part of the year 2000 audit in looking into it how you have responded to these recommendations. They go as far to saying that you have not adhered to the recommendations yet. That no progress has been made and very little has changed since the disclosures in the Auditor-General’s Report. Also that you have not gone as far as producing a detailed action plan where you set target dates to achieve the ends that we seek. In fact, alarmingly, if we look at the stocks level and just to give you some idea of the amounts of money that we are talking about here, your stock system only works in quantity and not by value, that there are exercises conducted to try and give an estimate of how much money you do have tied up in stock. The figure in 1994 was something like R35 billion, it went up to R50 billion the following year. In the 1996/1997 year we were given a figure of R70 billion. Miraculously in the following year 1997/1998 it dropped to R44 billion, crept up in the 1998/1999 year to R57 billion. The latest figures, the 1999/2000, they shot up from R57 billion to R98 billion. So if these figure are to be relied on and we are talking to close to R100 billion tied up in stocks. We need you to give us some general response as to what you are doing about the recommendations. Why have you not done more and essentially any other connected issues you can tell us about at this point? – [R Adm B W Visser] As far as your question is concerned, it is correct, argueing the point about accounting in volume and not in value. Taking it a little bit back and saying we need to consider that within the Department of Defence, especially within the National Defence Force, there is a strategic military appreciation that has been an ongoing planning process. We within the Department are going through a transformation process as well, taking us into a situation where each Arm of Service, that mean the Chief of the Army, Navy and the Air Force, need to consider what they would want to have in the new Force design. If you look at the new force design, there is obviously money required to drive this force design. But in the first instance there are some budget restraints which we cannot argue about, it is there. We need to do within that. Taking into consideration that there are some items on the shelve, we are now saying, for instance, the SA Army in their full structure has now decided that, not now but approximately four years ago already, the 35mm Olikon System, it is air defence system, should be phased out. We do not need this anymore. I have got documentation here that that has been an on-going process and because of the fact that this is a Special Defence Account item, it has been put on the market for marketing by ARMSCOR. About six months ago a particular contract on that was concluded. If we look at the amount of money in this financial year, it is about the R3 million worth of money of all the equipment that we are now phasing out. Taking it a step further and saying we have got excessive stock within the Department. The Department is closing in its folds saying we do not know what the next position is going to be as far as, first of all, military strategic appreciation, we can say that. Looking at the future at possible peace support operations, we need to consider ourselves, would we have sufficient to support that. Now those items that are in stock is not the items that we keep on buying with the limited budget that we have got. Those are the items sitting there to be used if it is necessary, that means insurance items. Or secondly, those are items that have not been considered yet within the strategic military appreciation that it will be done away with, with a particular Arms of Service and until such time that the command decision has been taken, that item will remain on the shelf. – [Mr J L Grundling] I understand exactly what is wrong and why this is audited and why findings are being made. I think we still need to answer and I think that we should go back to Adm Visser regarding the action plan that we are making in order to fix this problem. I would appeal that when we audit Defence regarding our stock holding and how well we manage it, that we first make an assessment of the condition in which Defence is trying to survive and function, because we are expecting rational management of our stock holding in an irrational context. What we have been trying to say in our explanations is that if there is not the correlation between the Defence policy as translated into, therefore this must be the size and ability of the Force and that there is money to back it up, all sorts of things go wrong. We have explained that the Defence finds it virtually impossible to rationalize its structure and its stock holding if there are not clear policy decisions about what is Defence required to do in future and there is proper funding for it. Just to give you one example. Our Defence Force, five years ago, it used to fly about 150 000 hours. Today it is flying between 40 000 and 45 000 hours. It is not because 45 000 hours is enough. It is because the budget can buy 45 000 hours. Now what do we do? Do we rationalize all the stock to give us a good stock holding turnover-wise for that amount of flying hours, only to discover that next year Defence becomes a higher priority, requires more flying hours because of disaster relief, going to the DRC and so forth and that money must start to be pumped into the system. It is not very easy to build up such a stock holding in such a short turnover time. This is very important, because Defence should not have money on its shelves when it could be used for schools and hospitals much better. But can we when we audit this, first make an assessment of the condition in which Defence is trying to conduct its business, then determine, as far as stock holding is concerned, what sort of margin or potential should we retain until such time as there is a proper co-incidence between the demands of policy for Defence and its funding. At the moment there is far too big a gap for anybody to try and act rationally as far as stock holding is concerned within that gap. – [Chairperson] The Committee would find your response altogether unacceptable. You are telling us that the Defence Force does not do what it should be doing and you are waiting for somebody to tell you. How far have you done in soliciting those policy guidelines which will in turn tell you as to what resources you should have?  – [Mr J L Grundling] We have for at least the last three to five years pointed out that there is a very big difference between the policy demands about the Defence White Paper in review as it translates to Force design structure and operating capacity. We have pointed out that this is under funded and we need to do one of two things. Either we reduce the demands of this policy so that it could coincide with the allocation or otherwise the allocation must coincide with the demands of the policy and within that we start to manage rationally. Going to the DRC, for example. It is a policy that we should be able to deploy for peace support operations. It occurred in this year and there was insufficient funding to, firstly, prepare such a force and also to fund such a deployment. And therefore during the course of this year we have had to make large investments in order to equip that force to go on such a mission. – [Mr B Nair] The answers must come from you. In these stock holdings that you have, because the issue that is arising is that your stocks rises to the tune of R100 billion and then in the process you have a whole lot of it. We were told a few years ago that you have cannons and other equipment from the First World War, your old collectors items. Are these going to be used in the DRC which justifies their holding? I am not trying to ridicule you, but why hold those stocks when the PriceWaterhouseCooper and consultants have made certain recommendations in regard to the stock and that is still being held. The question of the Chairperson has not been answered. I agree with you. that our commitment to going to the DRC or any other contingencies that may arise in the future, requires Defence equipment. But the existing stock, in your own evidence, are redundant and they are being kept in there. We are told that it is costed at market value. What is the market value of the old cannons? This is some of the things that we will have to tease out and recommendations have been made by the consultants from your report and which has not been carried out. This is the problem. – [Mr J L Grundling] There is old and redundant equipment, but there is also an initiative by government in developing the region and becoming involved in establishing democracies and professional Defence Forces and so forth, that a lot of this equipment is being passed as a gift to such nations. We sit with the difficult position should we liquidate that stock at nominal value just to get it off our shelves or should we retain it whilst we are waiting for clear decisions regarding our Force structure and design or hold onto it for these initiatives to emerge, so that such stock may be passed to those nations which government would like to back its diplomatic initiatives in Africa? So it might be very old and redundant for us, but for other emerging democracies and defence forces that is just trying to establish themselves as a professional force, that might be very usable equipment. Better than scrapped metal. – [Ms T Modise] I just wanted to say that are you not misrepresenting the facts a little bit here? Your response suggests that there has been absolute chaos in the Department of Defence. I seem to recall that there was policy, that this government adopted a posture which was defensive, that there is a force designed that was accepted, and that we should be spending according to that force design. I also recall that year after year there is a battle between Parliament and DOD (Department of Defence) as to how that budget should be aligned. We are sympathetic with the cuts, but it is absolutely wrong to say that we are completely neglecting. If you recall the last budget, we had quite a fight about why the coffers of the Defence Force were not being catered for? The suggestion by the Department of Defence is to say that because you do not give us X amount, which we are demanding now, therefore we will not do and we will not make sure that the core flight hours for preparation are covered. The suggestion is never that you must look at your salary structure and say is it in line with the core demands of the Defence Force. I think that the Committee would want to come back on this. I think also your response has also completely derailed the purpose of looking into stock holding within the DOD. No amount of talking about it is going to help us that you are holding too many stock that we do not have an inventory. That somewhere in the back of my mind that housecalls are okay to ensure that we get rid of surplus is another factor which can be brought in into looking into the issue of stock holding. – [Mr J B Masilela] Just some brief remarks on the statement specially made by the honourable member Mr Nair. We definitely know where the Defence Force is going. We have looked into the Defence Force Review, the White Paper, and the force levels that have designed the structures envisaged in that would clearly understand that and will adhere to that. But as Mr Grundling has indicated, the reality is that there is that gap in terms of what is required by the Defence Review and White Paper and the actual budget allocated, that is a serious gap in terms of that, but we have not highlighted that and sat down and folded our arms. What we have done in recognition of this gap, we have embarked on a serious process of military appreciation to bring in line what we have with what we are expected to do. We have costed this new structures and force design. We have taken it to the COD (Council of Defence) and we are expecting the Minister very soon to come back to us on this issue as a Department. In our analysis and engagement in this exercise it has become very clear that we will need to revisit the Defence Review itself. We need to revisit the White Paper specifically on this aspect. We have already sent some indication to the Standing Committee in this regard, but we are doing everything in our power to rectify the situation. – [Mr R C Anderson] I believe I must make two comments here. The Audit Committee has been very concerned with both dimensions of this issue. We are so concerned that we have submitted a special report to the Minister and the Secretary. I think we are faced with two issues here. One is that there is no doubt that there is a disconnect between the Defence policy and the budget that is allocated to achieve it. That is, I think, true. But there is another element, is that one should get this disconnect and when the Department is under pressure, it is very easy to blame the budget for inefficiencies. So we have highlighted to the Minister and the Secretary in a very forceful report the concern of the Audit Committee that these two events are occurring. I think that is as briefly as I can summarize a fairly complex report. – [Chairperson] We appreciate your comment. What we have learnt, and I do thank Ms Modise for helping us to set the record straight, that there is an assemblance, if not more, of Defence policy within which you have a framework and within that one talks separately about your stock management policy. I think the Committee would agree that there is no reason, notwithstanding certain valueness on the policy side, that you might claim to be there that you cannot, notwithstanding that have good stock management policy. Record keeping, as the Auditor-General has pointed out, there is no reason why you cannot keep good records. With good records your controls will improve. With bad records you provide opportunities for stock to do all sorts of things, not least of all to disappear. There is no reason why with some understanding, based on common sense if nothing else, that you cannot establish some sort of economic re-order levels and economic holding levels. It has been pointed out by the Auditor-General that this has barely been attempted and where it has, it is not really credible. So the issue, on one side, of purchasing stock without really knowing what you are doing and we see that in the increasing stock value over the last year, and on the other hand selling it off as obsolete or giving it away is of equal concern to this Committee. We would like to know that you have policy on the disposal side, that one is not just giving it away. One is trying to optimize what we get for that stock and on what criteria you decide to get rid of it. In our recommendations we are going to have to take quite a tough line on this and be very specific. We will consult with the Defence Committees of Parliament and get their advise on a few issues, but we are going to come back with quite specific requests to you on what sort of plan we want and when we want it and what that plan must contain. I do think, and I know the Committee feels this way too, that the issue has dragged on for too many years. We feel that, in your own way, you have been fobbing us off and there has been a fair degree of viscation if we go back through past records on this issue. We are now drawing the line and you will be hearing from us via our recommendations on this issue and how we go forward. Our next issue concerns the Special Defence Account.

Mr A Feinstein] I think that with respect to the issue of sensitive project, from your limited activities that were audited, there seemed to be some continuing problem, but perhaps more alarmingly, certain issues that have been raised for years and years now have still not been addressed. I want to, in general terms, hear very briefly from you and if you want to do that in writing, that is fine, what steps have now been taken to ensure that all financial requirements are adhered to with respect to the Special Defence Account?  Secondly, if you could give us an indication when the financial statements and audit reports for the front organizations will be finalized and made available to the Auditor-General? – [Mr J L Grundling] Regarding the Special Defence Account and the sensitive activities that are listed under there, we have for this financial year, the improvements that have been made have been indicated in our answers in the two previous answers that we have given you. They are briefly that each of these projects decides the aim and the motivation for that project that the activities that will be conducted in the year are very clearly defined. The control arrangements, both from a management point of view, a financial management point of view, as well as an auditing point of view have been vastly improved in the last two to three years. One can see it from the schedule of activities. This schedule is authorized on an annual basis. It is recommended by our Secretary for Defence, Accounting Officer and approved by our Minister, as well as the Minister of Finance. We believe that the control arrangements have been installed and one sees the improvement already. Unfortunately regarding two of these projects, and this is what has spoiled our Report in this regard, this was a problem that started in 1995/1996. Not proper attention was given to this. It came under my personal attention in 1998/1999 when we started to investigate this. Part of the documentation that we provided to you yesterday sets out exactly with respect to these two projects, inadequate financial statements have been produced, as well as audit reports that are still outstanding. We have indicated to you in terms of the Internal Audit regarding one of the projects. One of the steps that we have taken, we have also explained exactly why did it take so long to reach a conclusion, but the conclusion of that is besides the improvement of the control measures, and that the responsible person has been identified and the irregularities that he was responsible for and the financial value of that has been reclaimed from him and that money has already been received back. There is a full explanation of that in the document that we have given you. Then as far as the production of financial statements for 1997/1998, 1998/1999 and 1999/2000, there is a clear indication for both of these projects. If I could just give you the information in terms of Project N, that the financial statements have been finalized for 1997/1998. As far as 1998/1999 is concerned, that they are awaiting two overseas confirmations after which the statements will be finalized. As far as 1999/2000 is concerned, by the 31^st of October those statements had also been completed and the full management report will be given by the External Auditors regarding this particular project. All of these activities are absolutely transparent for the Auditor-General. Then as far as the second project is concerned, Project D, the financial statements have now been completed for 1997/1998. The Auditor wishes in this regard to also make a report and they wish to complete the 1998/1999, as well as 1999/2000, years together and then to produce a report. These Auditors have appealed that the organization be given the opportunity to get their asset registers top level together, which it was not before, and they are making good progress with this. The indication is that these three sets of statements, together with a management report will be provided by the 31^st of October. This is set out in the document which we did give to you yesterday. We undertake to report back on the 31^st of October that we have received these statements on. – [Mr A Feinstein] In the first instance, we must commend the SANDF for the progress that has been made, especially with regard to the case of the irregularity that you mentioned and with respect to the financial statements of Project N. The issue of Project D is slightly more problematic. The issue according to your document, that you made reference to seems to have been delaying matters and the improvement of the asset registers. To date this has taken more than 18 months to implement which seems an extraordinary length of time to finalise an asset register. You suggest in that documentation that the timeframes, that is in this particular instance, that the project should be afforded additional time to complete the implementation of the new asset register before the next audit has started. You say that those timeframes have been agreed with the Auditors. Is that correct? – [Mr J L Grundling] I cannot personally testify to this. This is staff work that we have done for ourselves. The officials that are working with the Auditor-General regarding the sensitive projects testify to this. I can confirm it. I understand from them that these timeframes, via our External Auditor, have been agreed to by the Auditor-General or they are at least aware of this. – [Mr A Feinstein] And in the document that we have received from the Secretary, it does say quite explicitly “the timeframes as mentioned above were agreed with the office of the Auditor-General”. Can I just clarify with the Auditors whether that is the case, specifically with regard to the asset register Project D? – [Mr E Smith] I am not aware of any such agreement made with the Auditors of the organizations. – [Mr A Feinstein] This is quite clearly an area that we need to clarify, because we have something very specific in this document. The only reason I raise this is because I would find it surprising if the Auditors would say that over 18 months has not been enough time to finalise or bring up to date the asset register, so have some more time until it is done. If we were talking about a few months I would understand it, but we are talking about over 18 months here. Could we ask that the Auditors and the Defence Force communicate on this matter and communicate back to us, as a matter of urgency, whether these timeframes have been agreed? If they have not been agreed, if we could get some sort of explanation as to why the sentence appears in the document we have received? If there has been a lack of communication internally within the Audit office, if we could please get an explanation of that?

Ms B Marshoff] I want to get clarity on the Report, on page 39 of the Auditor-General’s Report it states that the Special Defence Account is linked to the Medical Stocks Trading Account. Earlier on it was indicated that the Trading Account is going to be closed down and you were not given the exact timeframes. Now if that Trading Account is being closed down, will this be linked to the timeframes that you have identified now with regard to the Special Defence Account? – [Mr J L Grundling] No, there is not a link between the Special Defence Account and the Medical Trading Account. The Special Defence Account has an Act that governs it. I believe that it should continue since it governs the method of acquisition for Defence as far as we in systems are concerned. It sets in place very specific controls for sensitive activities as I have mentioned to you. – [Ms B Marshoff] The Auditor-General’s Report says that the bank accounts are linked and that is what I wanted to find out.  It is on the Auditor-General’s Report on page 39, RP134/1999. – [Mr J L Grundling] I do not understand what the question is. – [Ms B Marshoff] It is paragraph 3.2.1. I just want to find out whether the closing of the Trading Account of Medical Stock, what the link is going to be? Whether there is a link between the bank accounts, because according to this Report the Auditor-General states that the Trading Account shares the banking account with the Special Defence Account?  – [Mr J L Grundling] As I have it, the Defence has one bank account and the Trading Account for Medical Stock makes use of this bank account and the Special Defence Account makes use of this bank account. We have had our Reports qualified each year, because we have not created a separate bank account for the Special Defence Account. We have argued, from the Department, that to create a separate bank account for the Special Defence Account would not be cost effective. However, when we transfer to the new Management Information System  (MIS) with the implementation of the PFMA, we will without any question create a separate bank account for it. – [Mr N du Plessis] If I can just make a remark specifically regarding the Medical Trading Account, the possible date for the closing of that might be the reason that it must be at the beginning of a financial year when we will sort out all the problems before 1 April 2001. That would be ideal if we can do it that way. Treasury is in agreement with doing away with the Trading Account. On the financial statements, there is an indication that the financial statements for the Special Defence Account for the year 1999/2000 will be more or less finalized by the end of October. That is almost 7 months after the audited financial year and in terms of the PFMA, the audited statements must be completed two months after the end of the financial year. We have not got any indication from the Department. There is no PFMA implementation plan and how will they address timeously the representing of those financial statements.             – [Mr J L Grundling] The PFMA came into effect from 1 April, therefore the financial statements of these sensitive projects will be ready in time for the end of this financial year that we are currently in where the Act came into effect. The reason why there is such a delay in producing the reports of the year before the Act came into effect was that we had to try and reconstruct the business for three financial years, thus taking us a little longer. I believe that with the implementation plan that the Defence has that we will be able to perform in terms of the requirements of that Act in 2001 with the completion of this year’s business.

Chairperson] Our second part concerns the Special Review by the Auditor-General of the selection process of strategic Defence package for the acquisition of armaments at the Department of Defence. SCOPA has learnt a fair bit about the international experience regarding the somewhat murky business of arms procurement and arms trade. I think there are high sums of money involved. The possibilities for deals to be inadequately and inappropriately transacted often in ways which can allow for mistakes for irregularities and overall for significant unintended costs and losses to the state. The Review by the Auditor-General alerts us to such possibilities in the procurement deals we are shortly to discuss. And he does this by stressing the importance of predetermined policies and procedures and then the unwavering adherence to such policies and procedures. The Auditor-General goes on to give examples of where policies and procedures in these instances had not been adequate and where policies and procedures, to the extent that these existed, were not adhered to. We will be raising some questions in this realm of policies and procedures. The Auditor-General also brings a number of specific instances of concern to our attention which we will also be engaging department officials on. The Committee has received a number of submissions from public sources, most of which relate to that somewhat gray area of activity of transactions between the prime contractors and the sub-contractors. An area which the Auditor-General tells us in his Report that he did not really go into it. It was not really included in his scope. We note his recommendation that a forensic type of investigation might be advisable to look into this area. The Committee does intend to raise some questions into this area. Questions which concern issues which have been brought to our attention and we will do this with a view toward considering that Auditor-General’s recommendation of whether a forensic audit will ultimately be necessary, and if so, the nature of the audit, the extent of it and perhaps the minimal requirements of it. We will engage the Department in our questions in the hope of soliciting further evidence to that which we already has which will ultimately lead to the Committee’s resolution and recommendations it makes to Parliament and response to Parliament having allocated this Review to it. We cannot predict at this stage as to whether these Hearings will bring us to a point where we feel that we have sufficient evidence to make our recommendations or whether there will be another stage or two between this Hearing and our recommendations. The Committee will deliberate on that in the near future.

Mr L Chiba] The other issue that I would like to touch upon is the National Industrial Participation (NIP) which I will address to the Department of Trade and Industry. The third issue that I would like to touch upon is the adequacy of performance guarantee. Let me start with the cost of the strategic Defence package. In September 1999 it was announced that negotiations have been entered into with preferred bidders for the supply of military equipment and the cost of that entire package was R29.9 billion. However, the contracts were ultimately signed and we find in the final cost of the package it was R30.3 billion. We are given to understand that there was a Maritime Helicopter to the amount of R800 million which was excluded from the final package deal. We found that there is an additional R1.2 million that has crept into the cost equation. What does this increase of R1.2 million represent? – [Mr S Shaikh] There are many elements to the cost of the strategic package. The price that we received from the supplier is known as the tender price. We add to that tender price, like all other government departments, the price of the VAT duties, programme management, an ECA premiums, that is the premiums which guarantee the export guarantees. Now what is consistent is that we have decreased the tender price amount from originally R24.7 billion to R24.5 billion. In fact, on the cost to the state from the supplier we have decreased. The other issues of programme management cost is that we indicated to Cabinet that the Department of Defence did not make provision for managing the programmes, nor did they make provision for determining the cost of the ECA premiums, its export credit guarantees that we need to adhere to. We can only get to the cost of these ECA premiums after negotiations with the bank and we have done that. – [Mr L Chiba] I think that the manner in which the response has been presented to this Committee is not acceptable. I pose a simple question. R29.9 billion was the initial cost of the package, that was in September 1999. In December when the contract was signed it was R30.3 billion. What we need to do, if you make an allowance for the R800 million for the cost of the Maritime Helicopter that was excluded. Your answer that statutory cost was not catered for is incorrect. The R22.2 billion, the question of statutory cost such as VAT duties, freight, export credit guarantees were all included. I want to know where does the R1.2 billion come from. – [R Adm B W Visser] I have in front of us here a transparency showing the differences between the R29.92 which was the September the 15^th prices. On the transparency the R846 million was in the R31 billion in 31^st of August, but it was excluded in the R29.92 million in 15^th September 1999. So the price that we were working on was R29.92 million and that was increased with the final offers to R30.03 billion, which meant R58 million was added from the base price. That was due to the final adjustments of ECA and also programme and management. Our deviation, which is referred to, is from R29.99 million to R30.05 million. – [Mr L Chiba] I am not happy with the way their responses to the question was. Let me give you a simple example, R29.9 billion was the cost of the total package. From the total package R800 million has to be deducted for the cost of the Maritime Helicopter for which they decided that they prefer the purchase at a later stage. Instead of leasing the flight simulator, the Department decided to purchase the flight simulator which cost R900 million. If you do the arithmetic, you will find R29.9 billion less R800 million which brings it to R29.1 billion to which we must add R900 million for the flight simulator, which brings it to R30 billion. We still find R300 million excess. The R1.2 billion, all that you have to take off is the R900 million for the flight simulator. Instead of leasing it you decided to purchase it. The issue is it should the R30 billion, we find R30.3 billion. There is an increase from the 15^th of September 1999 to the 15^th of December 1999 when the contract was signed, R300 million crept into the cost equation. What is the R300 million? – [Mr S Shaikh] That is incorrect. There was no increase in cost with regard to the flight simulator. The increases to cost were because of the ECA premiums, that we needed to pay upfront in order to secure the bank facility loans, there is no package with regard to R900 million for the simulator. I would like to ask Gen Otto Schur to give you the true cost of the flight simulator, because there are an air package, which is the fighter programme package, as well as the helicopter package. He can discuss the flight simulator cost per package arrangement. – [Brig Gen D O Schur] I want to respond in terms of the flight simulator. The only one where there was an option to potentially lease such a simulator was on the Light Utility Helicopter (LUH) programme, the cost of which I deem to be exorbitant within the budget allocation and that was negotiated. We opted for acquiring only a cockpit procedure capability which was vastly less expensive than the figures quoted. I believe the figure is around 40 million dollars that were reserved for this functionality within the base price of the LUH. – [Mr L Chiba] You need to submit a total breakdown of the cost announced on the 15^th of September and the contract price that was signed on the 15^th of December to the sum of R30.3 billion. Our calculations are that there is a R300 million increase somewhere along the line. I would like the total calculation to be submitted to this Committee within the next week. The contract price was R30.3 billion. Are other escalation costs included? If other escalation costs have been included, what is the total escalated cost of the contract for the eight-year, as well as the twelve-year options. In other words, in eight year’s time, what will be the total cash outflow for this particular option and what will be the total cash outflow for the twelve-year option? – [Mr S Shaikh] The cost of the foreign programme is largely determined by the exchange rate at the time in which you fix your pricing base line. At the time we went to Cabinet in November 1998, we fixed the exchange rate at R6.25 to a Dollar. When we concluded contractual agreements in 1999 we had to move it to largely into a Euro base line, bearing in mind that the payments that the state needs to make back to the banks will take place some four to five years later. It is largely determined by the exchange rate at the time in which we make the payment. Escalation for equipment is largely due to the escalation with regard to the raw material cost. That is built into an escalation formula which is a standard procedure in ARMSCOR practice. It represent labour increase and material increase. That is the escalation formula that is universally applied in all acquisition programmes. The total cost of the programme, it is very difficult to give an exact figure now. It is largely due to the fact of what nominal terms are we talking about and at which exchange rate figure are we talking about. We know exactly what is the cost that we are paying to the contractor in the Euro figure or in the Dollar figure. – [Mr L Chiba] Could you perhaps tell me what was the Rand/Dollar exchange rate on the 15^th of September 1999? What was the exchange rate on the 15^th of December when the contract was signed, in Rand/Dollar terms? – [Mr S Shaikh] I do not have the exact exchange rate figures with me right now. The fact that on the 3^rd of December when we signed the contract, bear in mind that the Minister of Finance still had to negotiate the exact finance contract with the respective banks and that only took place at the end of February, early March. The first payment took place in this financial year on the 4^th of April. I do not have the exact exchange rate on the 4^th of April. – [Mr L Chiba] It is a pity that you do not have it. I will give you some figures about the exchange rate. On the 15th of September, the day the announcement was made on the arms package deal, the Rand/Dollar rate was R6.1792. On the 15^th of October it was R6.21, on the 15^th of November it was R6.20 and on the 15^th of December it was R6.20. So you will see that the exchange rate did not flactuate. It remained absolutely constant. So the exchange rate argument does not enter into this argument. As far as escalation costs are concerned, what will be the total package when we exercise the option in the year 2004 for the eight-year option and what will be the total cost of the package or cash outflow in twelve year’s time. Is it going to be R50 billion or R70 billion? Have you made a calculation? If you have not made a calculation, how would you motivate the agreement on figures that you do not know? – [Mr S Shaikh] All discussions on exchange rate are the discussions we have with the Department of Finance. The entire financing and payment of this package is largely directed and controlled by the Department of Finance. The Department of Finance sets the basis in which foreign procurement should be calculated in order to budget for it in their various multi-year planning. This is a fifteen-year programme that we are looking at. That element of exchange rate is introduced via the Department of Finance which took responsibility for drawing up the financial payment system with the respective banks. - [Mr L Chiba] All I am asking is a simple question. Has a calculation been made of what the total package is going to cost in eight year’s time or have they not made that package? Have they made the total cash outflow over a period of twelve years? Have they done so or have they not done so? And if they have not done so, on what basis do they motivate the arms deal? If they have not done so, fine, not a problem. They can do so later on and submit their calculations to this Committee within the next seven days. – [Chairperson] Can I just add to the seriousness of your question? Cabinet made a decision which on one side said spend R30 billion and get back up to R110 billion in off-sets. We want to know whether the Cabinet was told that that R30 billion was it? Were the other cost factors included? How well informed was Cabinet by yourselves in leading them to the decision they made? – [R Adm B W Visser] I can answer that the blue graph is the Cabinet decision regarding the R30.05 billion. Then in nominal terms, in other words, what is going to cash flow in the particular years per year totaled as a total in nominal terms. That was calculated with the indexes given between the Department of Finance and ourselves and on the 1^st of April 2000 the figure was R46.563 billion. Now with the latest negotiations between ourselves and the new industries provided by the Department of Finance, it is now calculated to be R43.828 billion. – [Mr A Feinstein] That is the inflation trend, but we assume that what you have factored in, as well, will be projections on exchange rates, as well as projections of inflation. Did those two lines reflect both of those? Over what time period is it? – [R Adm B W Visser] Yes. It is from now to 2011 and the reason why the programme extends is that our agreement with the Department of Finance will continue for two years after that to contribute from our Defence budget to the package still. Basically the programme on sign is from 2000 to 2011, 2012. – [Mr L Chiba] In other words, the original R30.3 billion escalates to R46.5 billion or whatever the case may be. Does this escalation include finance charges for that same period? – [R Adm B W Visser] The financing arrangement, in other words, the loan made between our government and the overseas banks, that loan only starts getting repaid in three years time and that is a matter between the Department of Finance and the overseas bankers, that those loan interactions from ourselves, we have no idea what that is, it is not a matter for us, it is only a matter between the Department of Finance and then to redeem that debt. – [Mr L Chiba] In other words, the finance costs are not included in the R46.5 billion. If we include finance costs over that period, are we then saying that the total package is then going to end somewhere around R50 billion or R65 billion and you have no idea what it is going to end up as? I do not think we should proceed with this particular matter, except to say that, please, furnish this Committee with the total escalation costs, exchange rate, labour costs, finance costs, whatever the case may be and give the nation an idea of what that total package is going to cost in eight years time when we exercise the option in the year 2004 and as well in twelve years time. I am sure they can make those calculations within the next seven days. We are meeting next week in a special meeting and I would like to have that information then. – [Chairperson] And in that submission could you confirm that those figures you present us with are the same figures which you gave to Cabinet on which they based their decision? – [Mr S Shaikh] Do I need to respond to whether the figures we show here that we took it to Cabinet. – [Chairperson] No, we asked you to respond in writing to that.

Mr L Chiba] The next issue that I would like to tackle is the question of National Industrial Participation (NIP) and I direct my questions to the Department of Trade and Industry. Now the way that this Committee understands the whole situation, among the objective of the Strategic Defence Package, that there will be a counter element of the Armament package due to the NIP. According to the Auditor-General’s Report, the initial cost of the contract was R29.9 billion while the off-sets committed in the industrial participation commitment were going to be estimated at a R110 billion, but while the final package cost increased to R30.3 billion. The industrial participation offer was actually reduced to R104 billion. What was the rational behind agreeing to a reduced industrial participation to the sum of R600 million where the contract price increased from R29.9 billion to R30.3 billion? What was the rational behind reducing the off-sets? – [Mr S Shaikh] I need to point out that the contract price decreased and that the fund of the Maritime Helicopters came out, it was a reduction in the amount of off-set with respect to the Maritime Helicopter. You need to take that out of the R110 billion. What we concluded with is about R107 billion provided we buy the other ………….. and we indicated to Cabinet and Cabinet made a pronouncement that there is a tranch reflect on the fighter aircraft. So we concluded from R110 billion to R107 billion and we concluded on the first tranch commitment R104 billion. So we have R104 billion in counter trade excluding the second tranch of the fighter aircrafts and excluding the Maritime Helicopters. Roughly the R3,5 billion was to build the Maritime Helicopter.             - [Mr J Naidoo] I am not an official of the government and I was appointed in November 1998 to lead the departmental negotiating team and I reported to the then Deputy-President and a sub-committee of four ministers. That team was compiled of a member of the Department of Defence and ARMSCOR, Trade and Industry and Finance. I had also acted in liaison with the Ministry for Public Works. The question that you asked will be answered by the representative of the Department of Trade and Industry. I thought I should just add a few words about it, because we changed the system. The numbers that were presented in November 1998 and the Cabinet decision was made public and the numbers that were presented at the end of last year when Cabinet made a decision, only bears a resemblance on the number part, but not the content of what it represented. In the departmental Committee, the negotiating team, was charged with two briefs, getting consensus about the affordability of the package, because the decision is subject to it being affordable when the decision is taken in November 1998. And secondly, to secure from the Defence contract the best possible deal in terms of the off-sets and managing the price. So the number of assessments we have done early last year about the risks and it is my conclusion, and the conclusion which was supported by the team and also by the Minister’s sub-committee, we reported that the system of industrial participation credits as calculated have many risks, Essentially because it awarded points to different kinds of activities on a multiplier basis. So there are certain points awarded for the economic impact of some things which were generally intangible and depended on subjected assessments. We, with the consent of the Defence contractors who had no option, but to consent in the tight situation where decisions may well have been made and impacted negatively on their programme, and with that coersed consent we changed the system to one we counted the value of exports and we counted the value of investments on a one for one basis. What this really meant was in practice to re-evaluate the continent programme and basically double the true value of the off-sets. So that R104 billion represents in real terms, as we reported in September last year, economic value that was far in excess of the original R110 billion which represented a lower economic value, because of the multiplier effect. There is nowhere in the world that you have got a 4 to 1 multiple for Defence off-sets to procurement. In real terms we have got a multiple. If you take out all elements of double counting, we have got a multiple of over 2 to 1, which is also quite substantial by international norms. These systems are generally calculated in terms of fairly complex procedures. Ours is much more simple in the final count as what it was originally. – [Mr L Chiba] Who were all the parties involved in drawing up the agreement? – [Mr J Naidoo] The tender set up certain requirements with regard to counter trade which replaced the NIP policy in the Department of Trade and Industry. The negotiating team, as I have described, were responsible for the negotiations of the various contracts. There was a contract which was the technical contract which was mainly conducted by the Department of Defence. There was the industrial participation contract which is negotiated mainly by the Department of Trade and Industry with a very active role from myself and the other members of the negotiating team. Those contracts were also in two parts. There was a NIP contract which is the realm of the Department of Trade and Industry. The Defence industrial participation contract which was of the Department of Defence and Armscor and then there were the financing contracts which the Department of Finance was leading, which was mainly with the institutions that were funding the deal, the banks basically and ECG. – [Mr L Chiba] I suppose all these contracts were done in writing and if so, could you submit copies of these agreements to SCOPA? – [Mr J Naidoo] They were all in writing. The contracts of the Defence supplier was signed in December and the contracts of the banks were signed by the Minister of Finance in January. This is contracts which are now housed in the respective departments. Each department has a record of their own contracts. It is up to House to ask the respective departments to produce those contracts. – [Chairperson] Mr Chiba, what are your thoughts on also calling for the working papers, the documentations which show the calculations and the formula? Can we set time limits as we go along on the dates. - [Mr L Chiba] We must give them a reasonable time limit and I think three to four days should be very reasonable. – [Chairperson] So that would be for the copies of the contracts and for the figure work that arrived at this R104 billion? – [Mr L Chiba] Would it be possible for you to submit those documents within the next few days? – [Mr J Naidoo] Yes.

Mr L Chiba] Then we proceed to the question of the adequacy of the performance guarantees. On this particular issue, we are not satisfied with the percentages that were agreed upon. The industrial participation offer played a very material role in evaluating the tenders. Actually it constituted one third of the total score of the total evaluation. On the other hand, according to the Report of the Auditor-General, the average was 10% of the contract price. Why did the performance guarantee averaged out in the 10% and not at 33.3%. Why were the performance guarantees not set at 10% of the NIP offer of R104 billion rather than on the contract price of R33.3 billion? – [Mr J Naidoo] The person in the Department of Trade and Industry who is responsible for this programme now was not involved in the negotiation process. He has asked me to take this question. I am not involved with the government on this programme at all right now. The NIP policy, in general, required a 5% guarantee based on acceptable performance guarantees. It was a huge part of the value proposition of this acquisition that there was a receptacle return for South Africa. The negotiating team, in looking at this, also concurred that the 5% hurdle that had been requested in the tender was poor. Although it was in keeping with international norms, it did not provide adequate comfort that these burdens in industrial participation obligations would be met. Through the process of negotiation that was increased effectively to roughly about 10%, which was when we have made a request in the tender for 5% to double it, was a feat that was not a feat that could have been achieved at the outset. In the future it is a matter that could be looked at in terms of a policy approach and what the impact is of having a higher performance guarantee in terms of the costing of the tender. We also secured a bank guarantee to that extent from most of the suppliers. It is not common for a performance guarantee to be linked to the off-sets. There is no evidence that we have found of that. It is usually the case that a performance guarantee is linked to the value of the contract, because the penalty is a portion of the contract. In the case where the value of the industrial participation exceeds the value of the contract, you have then this incentive for the supplier to agree to a performing industrial participation in excess of the value of the contract. The value of the contract is the base for calculation of all penalties. That is how the system generally works. – [Mr L Chiba] You make the point here that it was an achievement out of feat to increase the performance guarantee from 5% to 10%. Now 5% is R1.5 billion of the contract price. It should have been linked, in the view of this Committee, not to the contract price, but to the NIP value. And if there was something magical about the figure of 10%, then the 10% should have been there. Not 10% of the project price. That is all what we are saying. Can you give this Committee the assurance that the 10% performance guarantee is adequate to ensure 100% delivery of the industrial participation commitments. – [Mr B Sibisi] Over and above the 10% requirement that was imposed, there are other measures which were taken in certain instances to buy guarantees which was combined with the 10% penalty with the suppliers. For example, it all originated from the UK. The South African government entered into a declaration of intent with the UK government in order to give some further assurances that both governments will act together in ensuring that the commitments in terms of the NIP programme, which had been made by those suppliers, are going to be fulfilled. We have a consistent regular review of the commitment which are made and the projects that have been given as part of the NIP. We can make the information available to the Committee to ensure that the performance of the commitment made by the suppliers is fulfilled and that they will fulfill it 100% or 100% plus 1. It is a task that we have to ensure. – [Mr L Chiba] What actually happens here, if you are sure that there is going to be 100% delivery of the industrial participation commitments, fine. If the bidders said that that is what they are going to do, then comes in this thing in the tail, why only 10% performance guarantee. They should have then said no, we are prepared to give you 50%, because we are committed to deliver the off-sets to the tune of R120 billion. This is the issue. If they were so convinced and the negotiating team was convinced that they are going to deliver, then that percentage certainly should have been a far higher percentage of the performance guarantee and not at a very low 10% which was initially only 5%. – [Mr B Sibisi] One, it is a policy matter why it was approved at the 5% level. Other countries vary from 2.5% to 10% as their limit. Others do not even have any guarantees of this nature. They prefer to use other measures, like the black listing of the suppliers that do not fulfill their commitment. As a policy matter we opted for a 5% which was in-between. Mainly because if you state the 5% upfront, it is fair to say that any supplier of government will take at least some percentage and pass that over to government as built-in in the cards. So because the intensions and the objective is not so much of ensuring that you have money in the bank as the state, but it is ensuring a commitment not to be involved in the investment project or the sourcing from South Africa. It is important that this commitment is not pitched at a very high level. Remember, it is an up-front commitment that is made by the supplier. It is money that is in the bank and that is good. It is a cost to the supplier. So if you pitch it too high, it is a cost that might be fitted into the price. – [Mr L Chiba] The simple fact of the matter is this, that the lower the percentage of the performance guarantee, the higher the likelihood of the bidder opting out of that guarantee at the risk of a small penalty. This is the crux of the issue. You can be risky. That is a fact of life and we must not exclude the possibility that if they opt out of that, that a penalty of say R3 billion on a contract price of R30 billion, that R3 billion might have been included into the contract price already. – [Mr L Chiba] Who evaluated the NIP commitments? Somewhere along the line somebody says fine, these are the NIP figures. This is the evaluation? We have evaluated it and we approve it. Who did that evaluation? Would you furnish us details now or you can do so within the next few days. – [Mr J Naidoo] The process of reporting and approval was as follows. There were four meetings of the Minister’s sub-committee that took place during the course of 1999, which reported progress. In each meeting there were different levels of decisions taken which guided the negotiating team. The initial meeting took decisions which clarified the mandate of the negotiating team. In the final meeting a fairly substantial report was presented which covered all aspects, the financing, negotiations around the price, the industrial participation, a detailed macro-economic model that had been developed in order to assist the impact of this on the economy and certain studies that we also have done in order to assist some of the big high risk industrial policy based projects. That was presented to the Minister’s sub-committee. Based on that recommendations we then made further refinements and adjustments to be able to get the balances right and the consensus which was then presented to the Cabinet in September. It was a very substantial set of documents which is also accessible through the appropriate structures.

[Mr Chiba] Did all bidders sign performance guarantees regarding the industrial participation commitments? If so, could you perhaps furnish the full agreements to this Committee? Were there any non-costed options? If there where non-costed options, were the performance guarantee at a higher percentage than the ordinary costed options, because on non-costed options, the prices are quite high? Was the performance guarantee pitched at a higher percentage level? – [Mr S Shaikh] The debate on costed option and non-costed option was terminated in 18 November 1998 when Cabinet made a decision on the non-costed option. Thereafter, the negotiating team dealt with those preferred bidders. We had no mandate to discuss with the bidders outside the preferred bidders.  So the preferred bidders, as of 18 November 1998, when the negotiating team discussed it, and that was the costed option. That second phase of the negotiating was directed through the Minister’s Committee and that we continuously have interaction with regard to the programmes. - [Mr Chiba] Thank you for the explanation which is really not satisfactory. All what I wanted to know is was the performance guarantee pitched at in percentage terms or the non-costed option? Was there a performance guarantee or was there not? – [Mr S Shaikh] There was a performance guarantee as the tender document required 5% and as by Cabinet memorandum it was set at 5%. So it was pitched at 5% in phase 1. [Mr L Chiba]  In other words, what you are saying here, that in spite of the fact that the non-costed option, the cost of that particular equipment might have been quite high, the performance guarantee was only pitched at 5%. Is that how I am understanding your response? – [Mr S Shaikh] The tender goes out on a 5% requirement, which is government policy, irrespective of the cost of the programme, because the cost of the programme is only known to the Department and state when we receive the tender documents. We cannot pre-pitch the cost of guarantees before hand.  So we have determined it to be at 5% and in the second phase up it to 10%. - [Mr A Feinstein]  Are we going to come to the issue of the non-costed options elsewhere on the agenda?  The issues that we are discussing, which lead into the section that I am dealing with, we must make it very clear that this Committee does not deal with policy or adjudicate on policy. What is of concern to us is to ensure that the public monies are being appropriately utilized and that value for money will be achieved in the spending of public funds.  Hence quit obviously, both the actual equipment that we ultimately receive and the industrial off-sets of benefits that we receive are of interest to us. With that in mind, it just seems strange to me, and maybe Trade and Industry or possibly Mr Naidoo might want to comment on this, but is it not possible for us to spend R30 billion, or there about with financing around R43,8 billion, I think was the final figure, and    receive R104 billion in the first charge worth of new economic activity creating 65 000 jobs. I am just interested to know why most countries do not spend the vast majority of their budget on arms, because based on these numbers, it will massively increase economic activity and create all the jobs that were needed in the low employment economies, like our own.  To me, as an economist, it does not make sense. It is difficult to square theoretically, because if one looks at the literature on the matter, what comes through that literature, is that while industrialized countries often benefit from the economic multiplier effect, particularly relating to exports, but even in some instance to return the investment, developing countries very seldom do. There is also a significant body of opinion, and I am referring to the international literature here, that suggests that in many of these deals, in many instances the offsets can be significantly diluted. What seems to be very common practice is that companies negotiate postponements in terms of delivery schedules and this is where I am now referring to industrial offsets, sometimes re-negotiate the terms over and over.  Sometimes we even allow certain cases, that I am sure you are aware of, where the original agreement passes beyond the historical memory of the government people involved in the original negotiations. What also seems to be fairly common arising from the literature, is that the bidders, as the representatives from DTI (Department of Trade and Industry) have suggested, simply factor the penalties into the purchase price and they are only too happy to pay them. I have not heard anything at this point that convinces me why South Africa is going to be different.  I hear what you are saying about the 10%, but I think then, if you say that you are convinced, why did we not slap on 50% or 100%, because the bidders are completely committed to delivering on the industrial offsets.  Perhaps we will find the answers in the contract, but at the moment I have not heard anything, and I do not think black listing in this particular industry is something that proved workable historically.  I am looking for something more. – [Mr S Shaikh] I think too much emphasis is being put on the fact that the Department of Defence acquires equipment because of counter trade. So let me show you a slide, that is the state of the military equipment in the Department of Defence and the line that depicts the point of 2000.     – [Mr A Feinstein] To intervene, Mr Chairman, this is of relevance to my question in the following way if I can just explain it and Mr S Shaikh can indicate whether he agrees. We, as a Committee of Parliament responsible for the management of public funds, the deal has been presented to Parliament and we were told that R30 billion, in fact, between now and 2011, we are actually talking about R43,8 billion and there are various other factors that might change that figure that we do not have control over. So the R43,8 billion is being paid for armaments. There have been two fundamental reasons given, the one is the need for the armaments and this Committee certainly is not going to question that.  We have no understanding if there are issues whatsoever. The second is that we are going to receive massive industrial and export benefits from concluding these armament deals, which to a society that has a wide range of grave socio-economic conditions facing it, makes the spending of money of that order materiality relevant.  We take the equipment positions given, because we are not in a position to comment on that. What we are asking for is, we want surety that the economic and social benefits will be forthcoming. - [Mr J Naidoo]  Just to share a few thoughts, because the question is a general question.  I think the idea that industrial participation leverage on the Defence purchases can be a development path for developing countries, is a very highly questionable proposition. I think the more reasonable proposition is that, where a country requires certain equipment, it may counter balance the cost and the negative impact of that procurement by carefully managed offset programming. When you study these documents that come to you, you will find that the exercise was to maintain, at the least, a neutral economic impact over a course of the procurement exercise, rather than it be a generator of massive economic boom, which I think it would be a questionable thing.  There is a mildly favorable scenario that, first, depending on whether certain assumptions are realized, assumptions with regard to economic growth etc. This exercise on the offsets should be understood as a risk management exercise, rather than a growth generating exercise.  There are certain jobs that will flow directly and indirectly, but the numbers compared to the scale of the investment are modest. - [Mr B Kannemeyer] On the counter trade one, can we just get an indication, of the R104 billion counter trade that was indicated only R3 billion is guaranteed, which is 10% of the R30 billion, that there is absolute guarantee that R3 billion will be forthcoming and that at this stage neither the Department nor government can guarantee more than R3 billion, which is 3% or less of the R104 billion indicated counted trade of this. What is that figure that is guaranteed that anyone in government can say the counter trade that we can indicate is guaranteed is xy or z. - [Mr J Naidoo] There are 3 different types of guarantees. There was a performance guarantee when the Defence applied for the quality on their work. We did not change that. There was a guarantee for the Defence industrial participation which we did not change as well.  There is only a track record for Defence in that participation ten-year history and ARMSCOR has got substantial capacity for managing that very high rate of success with meeting the obligations that have been accepted by people who supplied equipment. The third guarantee was taken as a bank guarantee, so that money is committed and may begin at the will of the South African government should the supplier fail to meet any of the milestones with regard to NIP.  That is not entirely consistent in each package, there is a slight variation depending on the outcomes and negotiations and the specific nature of the contract and the type of industrial policy negotiation being done.  Generally in approximate a figure of 10% and in most cases it is a fully bank guaranteed guarantee. There is only one part of the equation of what underpins the assurance that the deal will be implemented.  Perhaps something of equal impact, maybe even bigger, is that the way in which the Defense  industry works world wide it is a basis of offsets.  A country that fails to meet his offsets is likely to be prejudice should it be bidding for work in another country where offsets are an important feature.  Those are some of the other pressures. If you took a bank guarantee of 100% it meant that the whole money that you pay the supplier is already attached to the bank account, so it is a real cost. It is not a normal guarantee, it is a financially guaranteed instrument. In order you want to raise it, it depends on what the assessment is of what the supplier is in any context with debt. That is how the system works. - [Mr B Kannemeyer] The question is really, all the other parts that Mr Nadoo has mentioned, has it any determination done of what is guaranteed. It did not say yes, it is only R3 billion, but in the answer, I picked up that he agreed with that and that is the guarantee in terms of the NIP, the National Industrial Participation, of that part. Of the DIP and the other part, that is a separate one. What we are trying to determine is that, of the R104 billion that was indicated as counter trade, what can be expected to be reasonable to be delivered upon.  It seems that the only amount in monetary terms that is guaranteed is 10% of the R30 billion which translates to R3 billion out of the mentioned R104 billion and if the counter trade part of deciding on who gets the bid or when we go ahead with it was 43% in deciding whether to go ahead with it, then it raises a serious question. - [Mr S Shaikh] The R104 billion is what we call commitments and we in the Department of Defence and the Department of Trade and Industry and the Department of Finance look at that as an upfront commitment and a guarantee. The word guarantee should not be confused with the guarantee with regard to putting monies into a bank fix. We call that, commitment, and we feel that of that commitment of R104 billion they have signed approved business plans, which can be inspected, and a separate legal binding document to those commitments.  So the commitments are in writing. They are as per business plan and it is legally binding to the suppliers of the equipment. The guarantees of the 10% is the money guarantee that we can draw it on. – [Mr B Kannemeyer] Just the enforceability of those commitments. – [Chairperson] Just address that and tell us what monitoring programme you have in place that will ensure that. – [Mr A Feinstein] With respect to that, I am not clear how one can legally bind someone to a commitment. One can legally bind someone to a contract. One can get material guarantees, as we have heard. I am not sure how one legally binds a person to a commitment. If we could also quickly get clarity, Mr J Naidoo has made the statement that this is not going to be growth generating, it is going to be economically neutral. Could we just get a sense on what is meant by economically neutral and if it is not going to be growth, I would also like to hear whether it is going to be employment generating or not.  I am missing the point of the whole offset. - [Mr E Sibisi] On the first question of what is meant by commitments, the  commitments are translated into a legal binding contract between DTI and various suppliers of firms which are linked to suppliers.  They have commitments not to perform in terms of those commitments. On the trade statement Mr J Naidoo made, I think the point needs to be made about the National Industrial Participation. If government does not go as a starting point to say that let us look for some acquisition of one form or the other in order to get industrial participation, I think the prior issue is whether there is any acquisition or procurement that the government needs to meet.  What we try to do with the industrial participation programme is to see whether we can leverage the purchase that government makes into the areas of the economy that will generate economic activities or increase economic growth, particularly in bank investment and sourcing from South Africa. You will be correct if you are saying that you are procuring government in order to generate a growth.  I do not think it would be a correct path to take, but where there is a given need for procurement, how does the National Industrial Participation use that opportunity to knock in a longer term with relation between the suppliers and the South African economy. Otherwise you would have suppliers having a long arm distance with South Africa.  What the programme tries to do and in the National Industrial Participation involving other government departments and parastatals, we have had significant flow of either investment or exports related coming about the leverage of the National Industrial Participation.  So I think the point would be the leverage on procurement that government does, but it is unlike general problems. - [Mr J Naidoo]  There were two things we will try with respect to deal with, when you borrow a large amount of equipment you have got to divert resources from elsewhere to the consumption of that. Secondly, when it is a large amount imports, you have a huge impact on the balance of payments.  Both these things are profoundly negative, because you are impacting negatively on growth and the balance of payments. To offset that you will have to find a way of restructuring the offsets so that there is a high level of exports, which makes the balance of payments neutral, and that you are able to trade in the replacement of where these resources have been diverted to investment that would fill that gap. The milestones were carefully structured so that the impact of the payment etc. and the impact that it will have on the economy will be offset by the deliverables and we gave ourselves sufficient space for deviations from the plan, taking into account certain assessments of risk and so on. We have build into that model a fair amount of room to maneuver before one endeavours to go back to the Cabinet to say that on the stir of things, this is now something that has minimum negative impact. - [Mr A Feinstein] To conclude on this aspect, the obvious former part that I think that I generally know that in many high growth scenarios balance of payments are skewed for a considerable period of time, especially in developing economies. I think what is extremely important is that we get access to those legally binding contracts that were referred to by DTI and that we examine them and that we then ask ourselves the question whether, as has been communicated to us and I heard various those people saying that we should underplay that link etc, and in terms of the way the deal was presented, the link was not underplayed. It was exactly the opposite and I think that is what we are taking as our starting point.  We have to establish whether we believe that we will receive over 100 billion worth new economic activity and create sixty something thousand jobs as a consequence of this heightened economic activity coming out of this deal. I think what also becomes critical is to ascertain what Cabinet’s understanding was in terms of what was communicated to them around the industrial offsets. - [Chairperson]  I think that last point is especially important. A lot of what has been discussed is not too relevant as yet. A decision was made at Cabinet which triggered all the transactions. On what basis were those considerations and that decision made? The announcements by Cabinet at the time were fairly unambiguous. We were going to spend approximately R30 billion and get back approximately R104 billion.  The longer we go on this, we see how vulnerable these figures become.  The more we look at offsets, the more conditional they are and things become increasingly ambiguous. We try to look towards what sort of guarantees we do have. On the government regarding contracts, we are led to believe and we will check that out that those agreements in no ways offer us any guarantees. It does appear that there could be one or two remaining questions. I think Bruce has one in particular on, it is all very well setting up this offsetting. How do you monitor to ensure that we do get back what we want to get back. We have been able to learn from  international experience that the trick is that you delay the offsets, you ask for extensions and slowly it disappears off the map. There is recorded experience of that.  Bruce, perhaps you can write your question down on monitoring and we could ask them to answer that as well.

Mr A Feinstein] I just want to move on and it is not unrelated to what we have been talking about, the certain aspects of the budget aspects of the deal. The Auditor-General has noted that instead of determining the funds available in government’s fiscal plans, the packages seem to have been negotiated before budget approval was obtained.  Could you just give us an indication of why this was or whether that perception of the process is correct? - [Mr S Shaikh] There are two parts of it. I will answer the first part and I will ask the Admiral to do the second. The fact that the package cost was a planning figure that the department of Defence had, the true cost of the programme was not known upfront, nor was it clear with regard to what are the elements within the package which Cabinet would accept for the Department of Defence and DTI and the Department of Finance to conclude contracts too.  These were discussions between the Department of Defence and the Department of Finance informing the Department of Finance upfront of the strategy, indicating to them that we will deal with the special Defence Account package as a separate line item in the budget vote system.  That correspondence between the Department of Defence and the Department of Finance exists. Provision was made in the various multi-year budget planning cycle to keep the package issues outside the budget until such time that it can be concluded as to what is the final figure that they will give permission to acquire. – [R Adm B W Visser] I think it is important to look at this a little bit in relation to the history of where we moved from 1997 to 2000. – [Mr A Feinstein]  There, as it has been said, there is a separate line item in the budget process, are they included in the MTEF for the following financial years?  If so, where are they included? I do not think we need the history particularly. – [R Adm B W Visser] All I wanted to say about the history was that we were in debt in the Department to the tune of R774,1 million over the last four years which we had to pay off and the last payment being in this year.  This year we started square.  We budgeted last year, in terms of our contribution to this Strategic Defence package, R117,2 million from our own budget and the rest was added to our budget inside this year. This year is the first expenditure on the strategic Defence package and from now obviously it will be in our budget. The portion that is real money is in the budget and the portion that is not real money, quasi-money in other words, relating to the loan that the Government pays on the overseas portions, is not part of our budget, but we get an indication of that money that we allow and we manage it on a fixed process. Yes, we did not have it in our budget, but there was no room in our budget, because the budget guidelines that we received over the last four years, never allowed for any inclusion of these three package, apart from the R117 million that is now in our budget for this year.  That is a very brief statement, but maybe it does not answer your question exactly.  -  [Mr A Feinstein]  Is there R117 million in your budget for this year for the package? How much in total will be owing during this financial year on the package? -  [R Adm B W Visser] In our negotiations with government, we allowed the maximum. Now that we do not have debt anymore to allocate to our Defence package and it’s R117,2 million this year of a total of R2 899 million.  That is the total cash flow projected for this year.  This figure, however, had been adjusted slightly. Because of various factors we are now going to spend R50 million less than planned, so we will spend a total of R2 849 million of which our contribution from our own budget is R117,2 million. - [Mr A Feinstein]  So the balance of the R2 849 million excluding R117 million comes from where? - [R Adm B W Visser] That balance comes directly from foreign government as an allocation to our MTEF process for this year, which started last year, and the letter was written in November last year to indicate that this would be our MTEF figure for this year.  So we included that, but as I said, some of that money is not real money, because it only goes according to the accumulation of loan overseas in the Government books.  Its not really cash flow that really flows. It’s just that you get the figure of what it should be in terms of the accumulation of the loan. - [Mr S Shaikh] I have indicated earlier on that the Department of Finance has concluded a loan agreement with the respective banks.  So when we use the word “quasi”, we mean that the banks pays the supplier, but it has to be shown on the books of the MTEF as an entry in the Department of Defence account.  That money doesn’t physically exist in the Department of Defence account.  Its monies with the bank which the bank pays the supplier. The word “quasi” is in respect to the bank having the moneys that have been paid to the supplier.  That loan agreement is a loan agreement between the Department of Finance and the respective banks, but the full amount that is paid to the suppliers, in a particular year, is indicated in the Special Defence Account. - [Mr A Feinstein] I think there are a number of issues here that we might need to take up with the Finance Department or even the Finance Portfolio Committee might decide they want to take them up.  I wonder if it would be possible to now move on to the issue of the asset contract part.  I do assume just by the way that all Government contracts of this and other nature, if Parliament doesn’t vote those funds in any particular financial year, there is some sort of exit clause and Government couldn’t commit itself to spending money that hasn’t been appropriated by Parliament.  Maybe somebody could just give an indication of that and in the first response to the issues around the prime and subcontractors. In terms of the Auditor-General’s Report, the issue of prime and subcontractors has been highlighted as an area in which they did not investigate very closely and in which there are certain gray areas. Now, for us in trying to establish that link between the prime and subcontractors, I came up with two possible interpretations of opulence between prime and subcontract.  The first is that the Department of Defence had very limited control over the avoiding of subcontracts and given issues such as the cost of the package, accountability for public funds and the national interest, that will seem quite strange to me. Maybe you could indicate whether that interpretation is correct. - [Mr S Shaikh] The package concept was initiated from a Government to Government initiative.  All tendering documents were issued to the respect of embassies, be it the UK Embassy, the Swedish Embassy, etc. and respective industries invited their industries to partake. One of the reasons to move the level of Government to Government is to ensure that there is a Government commitment to the pricing structure, export guarantees that we require, a Government commitment from the banks to ensure that the South African Government gets the best interest rate to ensure that the foreign government supports the industries in meeting the offset agreement.  We have to move the law to what we would call prime contractor. Those are taking full systems responsibility. There are respective guarantees of performance of equipment and there are guarantees who will describe to the technical performance, guarantees on both the counter trade, the NIPs and the DIPs , as well as guarantees in the financing that we pay upfront to the respective suppliers.  So there are four different types of guarantees.  In order for the South African Government to ensure the guarantees, we had to move the moral to what we call main system supplier, for these are suppliers as nominated by the respective governments as the Tender of 72.  So yes, we have got to seek Cabinet approval to ensure that the programme of tying up contracts at Level 5 is what is our responsibility and the respective local industries, as well as foreign industries, have to sell their worths and and their technology to the respective Level 5 main system supplier. - [Mr A Feinstein]  If that was the case and there was limited control over that process, what controls were put in place by the Department of Defence for that stage of the process, because surely you had to assure that that aspect of the process happened according to certain agreed to policies, procedures, etc?  - [Mr S Shaikh]  In the tender documents that went out, the respective projects were given what we call a direct counter trade weighting in respect to the submarines. It is roughly 10% direct work related to it and we set on each project, depending on our local industries capability, a minimum figure for the foreign supplier to commit to.  It was set with regards to the counter trade commitments directly relating to the project. These figures were made known to the suppliers and we use it as a basis of a minimum figure.  We ensure that the suppliers met the minimum committed figure in percent items, not necessarily with regard to which supplier they particularly choose to use.  We further ensure that through a project team process that the supplier remain contractable, recommending the sub-contracts to us that we ensure that we concur with the recommendation.  It was their recommendation. We either support or reject their recommendation. - [Mr A Feinstein]  The actual issues of policy, ect, as I understand it, will be taken further by Mr Leeuw in a later section.  So I am not going to dwell on that.  Short of to say and obviously Mr Leeuw’s questioning might affect this, it will be very useful to see all of the guidelines that governed that process and how they will monitor it.  I want to move onto a slightly different level. What steps were taken, given that this decision was made around prime and sub-contractors, to ensure that there could be no conflicts of interest in that stage of the process? - [Mr S Shaikh] I have compiled a set of presentations to hand out to the individual members.  You said that we should not do the presentation, I will speak through it, but we have a set of documents to that.  The very programme before the package deal was the Pilatis deal that was the acquisition of 60 trainer aircrafts.  In that process we had one negotiating team and one team that did the entire evaluation and the highest level of approval within that process was the Ministers Committee then.  In this particular process we made it multi-departmental. We invited in the negotiating team the Department of Trade and Industry, Department of Finance, ARMSCOR, the Arms of Service.  So it is a multi departmental inter and external departmental approach.  There were four phases to it. There was a policy phase, a Management Committee phase, an evaluation phase and a negotiating phase.  Not all the Members in each phase were identical.  There were four areas in which evaluations took place resulting in a 300% point score.  Fifty points were given to the Defence counter trade  handled by ARMSCOR and the Arms of Service.  A further 50 points was given to DTI handled exclusively by DTI, they made up 100. The second 100 points were given to the Department of Finance, including the Department of Defence, Finance Department.  That made up the second 100. The third 100 points was given to the technical team, whether it was the Air Force and ARMSCOR doing a technical evaluation.  Each scores of the 4 teams were kept separate.  No one team was given all the documents.  The ARMSCOR Procurement Secretariat manages the programme.  They issued the tender document.  They received the tender document.  They break it up and they give the respective 4 teams just their part of the documentation for evaluation.  To ensure the fairness, we had a sub-com meeting where each team presented their results on the same day, the same hour, and clinically, the scores were added. Those scores which resulted in 300 points were then presented to the respected forums.  At no point in time were the sub-com mandated to change any of the point scoring system that resulted.  So we have 4 teams, 4 programmes resulting in the 300 point score and those 300 point score was recorded on the same day as the scores were recorded.  What we felt is that if we take the process away from individual decision-making to a collective decision-making, we will enhance the programme substantially. You had to go and speak to the Department of Finance, Department of Trade and Industry, Arms of Service, Department of Defence headquarters, ARMSCOR, each of these teams were independent teams and no one team had information of what the other was doing.  To ensure that the programme was even further brought to the attention of Cabinet, there was a Cabinet Subcommittee that we briefed extensively in 3 sessions with regard to the point scoring methodology we used. - [Mr A Feinstein] That sounds very good.  Obviously we need to look at those documents that you say you have prepared and maybe raise some questions arising from that.  So, from this process it would be possible, in a further investigation, to follow the trail of a particular aspect of the deal from the lowest of these committees, lowest being a generic term, where it would have been scored.  And we could see those scores through the other phases to the final decision and what that would reflect, is that the decision would reflect the scoring in that initial phase. Is that correct? - [Mr S Shaikh] All documentation proof of each scoring team is recorded.  It is a comprehensive document. It shows you the members that scored, exactly what point scoring. To walk you through a technical document, a technical document for the evaluation of any particular equipment is a very comprehensive point scoring system.  It even gives you an indication which member or group or collectives score on a particular issue. Take for example logistics engineering, whether the logistic document was in that group’s opinion, of a 10 point score or a 3 point score.  Which of those members that even scored those points is recorded ? - [Mr A Feinstein]  So the scores might have actually changed as they went through the different levels. The original score, the original group would stay as they were, but then when it goes a level up, there would have been another scoring process or not?  -  [Mr S Shaikh]  No Sir. There is only one scoring team and that is the Project team and they are the only ones who are entitled to score.  No one else scored except that particular team. - [Mr A Feinstein] So that score would then form the ultimate decision? -  [Mr S Shaikh]  Yes.  -  [Mr A Feinstein]  I understand that.  Now, when we come on to the issue of the individuals, and as you have said, there was a myriad of structures within Government and parastatals around the deal.  Our assumption is that every individual involved in any way in any of those processes signed a declaration indicating that either they had no conflicts of interest or identifying areas where they might have conflicts of interest.  Is that correct?  -  [Mr S Shaikh]  In the process that is the part that’s lacking and we upfront admit that we should have had a declaration of interest per person, per individual, per project.  These projects were conducted under the ARMSCOR process and there is no policy or procedural document today that says when should an individual disclose his interest.  There is precedent that says an individual should disclose his conflict of interest when the matter serves before him.  That is some issue that, we upfront accept, is lacking and we concur with the Auditor-General’s Report and necessary steps are being taken to correct that. - [Mr A Feinstein]  Is it not a little late now?  -  [Mr S Shaikh]  Once it is a policy document within the ARMSCOR Act that did not make provisions for that, yes, we admit, it could be a bit late, but we did say upfront, we moved the process away from the individual base to a collective base. -  [Mr A Feinstein]  What is being said is you work according to ARMSCOR systems even though the Department of Defence was involved, and Finance, Trade and Industry and ARMSCOR is a parastatal.  Now, instead of normal procurement practice, what does it adhere to? Our paragraphs C, 3.3, 4.6, and 5.7 of the Public Service Code of Conduct, Treasury instruction N14, State Tender Board Regulations 37, and included in this is that all staff on Tender Board sign declarations of Conflicts of Interest in the beginning of processes.  Now, this is what is done in normal “run of the mill” procurement processes that by comparison to this particular arrangement, it is somewhat tight in terms of materiality.  I would have thought that given the huge cost of this deal, the controversial nature of arms deals internationally and the broad public interest that needed to be safeguarded throughout this process, you should have actually gone way beyond these “run of the mill” guidelines.  Instead, the reverse has happened.  Is that correct?  -  [Mr S Shaikh]  Can I just comment to policies, procedures and documents as spelt out in the ARMSCOR Act. – [Mr A Feinstein] The issues for us is that this is Government money, whether we describe it as “quasi” money, funny money, hard money, it’s Government money.  What I am talking about here, as I understand it, applies to Government departments own parastatal entities.  They can certainly go beyond these guidelines, but not below them. - [Mr B Kannemeyer]  I was just wandering whether we should relate to it, because the problem deals exactly with the Minister of Defence Policy for dealing with International Defence Equipment Officers office in the LOD.  I am just a little worried about the answer that was just supplied that this whole deal was done in terms of the ARMSCOR process. From the documentation that we have, it says in the Introduction of this LOD Policy that these International Defence Equipment Office fall outside the scope of existing Acquisition Policy and specific policy for such International Defence Equipment offers has to be established.  There is such specific policy.  Its not in terms of the ARMSCOR Policy, so it was on that point, without going into the rest of the policy which was supposed to guide this, that I just wanted Mr S Shaikh to give clarity when he says it took place in terms of ARMSCOR only.  -  [Mr A Feinstein] There are a couple of other questions.  Do people want to respond to the Mr B Kannemeyer now?  - [Mr S Shaikh]  Yes I would like to respond to this now.  The policy that we are talking about in the first order value system was a draft document that was not approved by the Council.  Second, it doesn’t talk about ARMSCOR.  ARMSCOR is an Act, it is not a Policy.  It’s the Policy relating to how we do this management and that policy is spelt out in what we call the Department of Defence, BB1000 Policy Document.  So with respect to the BB1000 Policy Document, where we move from a start target to a development plan etc, that is the relationship we are drawing to and that is the part we say about upfront, yes, we concede that we went from an acquisition from a start target to an acquisition plan.  We did not follow the sequential steps in Acquisition Management and it is a policy that we are relating to there.  -  [Mr A Feinstein]  I think I should just say that our understanding is that public moneys are dealt with in a particular way and determined by the various pertinent regulations that are mentioned, and primarily the Exchequer Act going into the PMFA, as you are aware. I have to say that this is complete news to me that different departments can decide exactly how they are going to procure, especially on issues like declarations around conflicts of interest which are absolutely essential to the integrity of the management of procurement policy.  Now, maybe at some later date the Office of the Auditor-General could advise us to something different that we are not aware of.  This baffles me. I want to ask a number of questions related to this. Is there any possibility that there could have been, either formally or informally, deals struck between potential private contractors and potential subcontractors before the prime contracts were finalised?  -  [Mr S Shaikh] That question is a difficult question to answer with respect that it is a deal struck between the prime contractor and the subcontractor which we are not aware of. - [Mr A Feinstein] So we do not know? - [Mr S Shaikh] No. - [Mr A Feinstein]  So in other words, what we are saying is there is the possibility that deals could have been struck between prime contractors and subcontractors before the prime contracts were finalized. - [Mr S Shaikh] The issue is what is your definition of the word “deal”. What we are saying is that we have an acquisition programme and in the subcontracting of work to be done on that particular programme.  If that is your interpretation of your “deal”, yes. - [Mr A Feinstein]  Sorry, it was extremely loose diction.  What I said upfront might have been unclear, either formally or informally? Formal would be a deal and informally there might have been an agreement that in the event of XYZ. - [Mr S Shaikh] I said every contract from the prime contractor to the subcontractor in the counter trade in the Defence part is documented and it is signed for on each contract. We have a very extensive contractually binding the main contractor to the subcontractor and its defined specifically in this task and the work to be performed. – [Mr A Feinstein] Is it feasible that negotiations around subcontracts might have in any way, directly or indirectly, influenced the choice of prime contractors?  - [Mr S Shaikh] No. - [Mr A Feinstein] Unequivocally no?  - [Mr S Shaikh]  Unequivocally no. The value system and the point scoring system can reflect that. – [Mr A Feinstein] Was there at any point in the process, to your knowledge or to the knowledge of anybody else appearing before us, any contact between people involved in the various Government committees, processes, structures and potential subcontractors prior to the signing of the primary contracts? - [Mr S Shaikh]  We ran official workshops and the rule that we applied was that any prime contractor and subcontractor is welcome to engage the respective departments up and until the time the tender documents is submitted in. This allowed the Department of Trade and Industry to interact with the respective bidders as to the type and nature of the programmes that is required by the South African Government.  This allowed the bidders to interact with the Department of Defence Officials with regard to the type and nature of the requirements and the evaluation of it.  - [Mr A Feinstein]  Are you talking about the prime bidders or the sub-bidders? - [Mr S Shaikh]  We are talking mainly about the prime bidders and their interaction with Government Officials took place up until the time the tender was submitted.  - [Mr A Feinstein]  We could pretty much say a fairly significant number of the people in those various Committees in that structure might well have had contact with the prime contractors and the subcontractors prior to the finalisation of the deal.  Is that correct?  -  [Mr S Shaikh]  Yes.  That being due to the fact that the bidders had contact with other Government Ministers and other Government Officials. the programme of trying to solicit the best value for the State was the prime consideration and the only way you could engage with the bidders with regard to your equipment requirement, what is interpreted by prizes offset expected to be materialized is by an engagement and the rules were fair. We had an open 2-day workshop session where we brought the foreign bidders as well as the local suppliers together.  We explained the process.  We explained the programme to them.  So this was like upfront, in public and we invited many departments to join this. - [Mr A Feinstein]  And that would apply to the subcontractors as well?  -  [Mr S Shaikh]  Definitely.  -  [Mr A Feinstein]  If I could then move on?  You mentioned that there was no sort of Formal Conflict of Interest Declaration signed where people felt that they had a conflict of interest they would then verbally state that they had a conflict of interest. Did that, in fact, happen on occasion?  -  [Mr S Shaikh]  Yes, it did and it was recorded in the respective meetings where decisions of direction was given. - [Mr A Feinstein]  What sort of occurrence are we talking about here?  Did it happen one or two times?  Did it happen a dozen times or a hundred times?  What are you talking about?  -  [Mr S Shaikh]  - With respect to individuals or with respect to the number of times individuals have to restate their conflict.  I am not too sure Sir.  -  [Mr A Feinstein]  The numbers of individuals, firstly, and secondly, the number of matters or issues on which there were conflicts of interest, so two different figures. – [Mr S Shaikh] I do not have the exact figures.  – [Mr A Feinstein]  Can we have the figures of the minutes/recordings so that we could get some sense of what those statements were.  Can I then clarify?  My assumption is that when this informal protest of conflict of interest was declared in a particular meeting, that that person who had that particular conflict of interest would have, one, physically left the meeting;  two, would have had its various committees/forums that were making these decisions around the area over which there was a conflict of interest that there would have been no exchange of views, information, documents, etc. around those specific issues. Will that be correct? - [Mr S Shaikh] All decisions or recommendations, or support came via the project team to decision-making forums.  The answer to that question is yes.  A recusal did take place by means of leaving the room, by handing over the Chairshift to a more senior officer of the day.  - [Mr A Feinstein]  And any sort of communication around those particular issues between people who had stayed in the meetings and those who have an interest?  - [Mr S Shaikh] With respect to the communication, the communication is in so far as the decision to be taken and that decision to be taken, once, was presented by a project team. - [Mr A Feinstein] The question is whether there would have been any communication/contact/flow of information around particular issues that someone might have recused themselves because of the conflict of interest between those persons who recused themselves and those persons on the teams that made the decisions? – [Mr S Shaikh]  Information was only presented at a particular forum.  More meetings or presentation of information took place outside a particular forum and a forum could be a Committee called the Project Control Board, the Armaments Acquisition Council.  So, no documentation flow outside that other than at that particular meeting.  – [Mr A Feinstein]  So there would not have been any informal discussion around it?      – [Mr S Shaikh]  No other than when the subcontractor requested such a meeting.  – [Mr A Feinstein]  No sorry, the subcontractors do not come into this part, because I have seen that the subcontractors requested a meeting.  The person who had recused themselves is having a conflict of interest relating to that issue would have recused themselves in relation to that meeting with the subcontractors.  Is that correct?  – [Mr S Shaikh]  Not unless the subcontractor requested such a meeting.  There’s a particular case where that happened and we have documentary proof to show that the subcontractor, in fact, requested the meeting. – [Mr A Feinstein] Did the subcontractor request that the person who had a conflict of interest be present in that meeting?  – [Mr S Shaikh]  Yes. – [Mr A Feinstein]  The person concerned plus the team overall that met with the subcontractors didn’t have a problem with that.  – [Mr S Shaikh]  Once, the subcontractor requested the meeting.  He requested that the person be part of that meeting. It was not around the selection of the programme.         – [Mr A Feinstein]  Sir, with all due respect, the contractors, from prime to sub to tiny, could have requested all sorts of things to ensure they got the deal.  They could have requested, please give me the deal.  That does not mean that we have to say, of course, you have asked, we will do it.  The point I am making is, does it not seem strange to you that an individual who has a conflict of interest should participate in a meeting directly related to that issue of concern with other decision makers around or without. – [Mr S Shaikh]  Once, there is one particular period of conflict of interest where that particular sub-supplier, who did not want to deal with the main contractor, requested that the Department and ARMSCOR convened with him at his company to discuss Government’s direction with regard to contracting at Level 5, not the particular issue of his particular company and that we have in writing and we would like him to submit that as evidence. – [Mr A Feinstein]  And you will give us the details of the people involved, etc.  Was this conflict of interest communicated either to the relevant Minister or Presidency or both? – [Mr S Shaikh]  Yes, it was presented to the Ministers.  It was recorded accordingly that the conflict of interest does exist with the Minister. – [Mr A Feinstein]  If we could also have proof of that communication with the Minister. I want to ask whether you can give us an unequivocal statement that nobody, and we are not sure whether we are talking about one or two people here or a hundred people who have conflicts of interest, could not have in any way impacted on the ultimate decisions taken with regard both to the prime contracts and the subcontracts. – [Mr S Shaikh]  I can unequivocally state that the process does not allow for any individual to influence a process of this magnitude and the answer to that is no.  – [Mr A Feinstein]  I think, Mr S Shaikh, we all know as human beings the extraordinary things that individual human beings can do.  In your view, is there any possibility that in addition to what you have told me now about this one instance, there could have been conflicts of interests that were not stated through this informal process or there could have been engagements that might have violated the conflict of interest that existed?  Can you say unequivocally that with the exception of the one case you have mentioned that you will provide us with information on, there is no other instance where conflict of interest was not stated and the person physically left the room, did not communicate with anybody related to that particular matter or issue? – [Mr S Shaikh]  I need to go and research every meeting that transpired to ascertain whether that was true in many cases. – [Mr A Feinstein]  My suggestion is that rather than there being an internal investigation, if you cannot give us that unequivocal undertaking, I would suggest that this is an area that we might want to give some thought to investigating further.  I must be quite frank, that I find, one, the informal nature of the way conflicts of interest were treated in the deal relating to R30 billion,  I found it astonishing in the first instance. I also find it worrying that there is one case, at least, of a conflict of interest, but we will look into that where the person actually participated in the discussion around that particular issue regardless of whose request it was at.  Thirdly, that we do not have an unequivocal negative that there could have been any other conflicts of interest throughout the process of awarding the prime and subcontracts.  That’s all.

Chairperson] Can I just ask one question?  African Defence Systems (ADS), what role did they play?  What influence did they exert on the selection of subcontractors?  – [Mr S Shaikh]  The decision toward the ship together with the hull and the combat seat was given to the German Figured Consortium.  The German Figured Consortium elected to use African Defence Systems, in fact, it was then Altec Defence Systems.  It is the same acrement, ADS, elected to nominate Altec Defence Systems to African Defence Systems as the Combat Street Intergrater.  For that decision, both Thomson, which is the parent company for African Defence Systems, had to provide the entire performance guarantee of the entire ship, as well as introduce counter trade in respect of the commitment of the combat’s field.  So that is an arrangement between the German Figured Consortium and Thompson/ADS with regard to the Combat Street element.  The German Figured Consortium and ADS were given a list of candidate suppliers to use into their product into the Combat Street of which the entire risk fell with the German Figured Consortium. Elements of risk was introduced where companies were not prepared to carry their own risk and passed on their risk to the main contractor.  That contractor notified the Department that there is a risk element and either the Department of Defence fixed the risk or transferred it back to the company.  If the company does not want to pick the risk, the recommendation from the German Figured Consortium was that they would not accept that company’s risk to the product.  It’s ultimately the performance guarantee of the entire ship, that was the issue of the day. With respect to your question of the African Defence System, we have a comprehensive list of every defense industry company and what value of work they have received be it in direct form, indirect form or what we call technology transfer.  We would like to hand the copies to the respective Members, so that they can look at the amount of value of work given to the South African companies to date. – [Chairperson]  So you have fully answered my question.  Did ADS receive any monies from the States for any of the activities that was engaged in, concerning these contracts? – [Mr S Shaikh]  We provide all monies to the Corvette Consortium, which is the German Figured Consortium which sponsored ADS became a consortium member.  The monies do not go directly to ADS, because of the European Figured Consortium.  – [Mr L Chiba]  Did I understand you correctly to say that Thompson was the parent company of ADS, and if so, when did it become the parent? – [Mr S Shaikh]  Auditor-General, I have presented documentation to that effect and I have it in our possession. We have 30 copies of that detailing exactly when did ALTEC Defence System sell off 50% of their company to Thompson France, the parent company. At that particular point the Chairmanship of ADS remained with Cape Venter and at which point the balance of the 50% of ALTEC Defense System was sold to Thompson France.  So it was a two tranch selling of the process and when did Thompson France reintroduce the company into Thompson South Africa.  It’s a 3-year time line.  It did not happen in one go.  We have a slide presentation and a documentation presentation.  We would like to hand it to the Members. – [Chairperson]  Finally on ADS, were there any potential conflicts of interest there between Directors of ADS and the Department. – [Mr S Shaikh]  With regard to the conflict of interest with ADS, I have stated my particular conflict of interest and I have recused myself from any particular decision relating to the Combat Suite and that was duly recorded and stated. – [Mr A Feinstein]  I am sure your document will indicate this to us.  There has been some sort of tie up between NBS and is it FBS.  Is that correct?  There has been some sort of consolidation there.  Are there any direct or indirect links between these two companies? – [Mr S Shaikh]  The shareholding of the African Defence System is now 80% Thompson South Africa, 20% FBS of which the costing of that company is unknown to us. – [Mr A Feinstein]  What aspects of the overall procurement deal are FBS involved with. – [Mr S Shaikh]  There is one other area in which FBS has been given work in the logistics domain.  It is a credited supplier to the Department of Defence. ARMSCOR once had an accreditation system.  It is in the Light Utility Helicopter domain and the total amount of work given to FBS was R35 million. – [Mr A Feinstein]  Did you declare your interest in that aspect, even though it is a indirect interest, given your interest in ADS? – [Mr S Shaikh] I do not have a conflict of interest with FBS.  I had a conflict of interest with ADS as a family member became  a Director this year in ADS and I have declared that conflict of interest. – [Mr A Feinstein]  So that would pertain to both of the aspects that you have mentioned, because ADS is also involved in the aspect that FBS is involved in? – [Mr S Shaikh] With regard to the Corvette programme, that is the only area I reiterate that I have a conflict of interest. – [Mr G McIntosh] In the Auditor-General’s Report he says that although procedures were in place to obtain capacity to support the international office negotiation team the required ARMSCOR tendering procedure was not followed in all instances. I think you have made a very valiant attempt and I am not suggesting it is not anything but bona fide to show that you wanted to develop an enriched process for evaluating what is a huge deal in the South African national interest.  I do not want to query your motives, but would you care to say whether you did or you did not follow the required ARMSCOR tendering procedure, because you actually admitted as much as that. – [Mr S Shaikh] The CEO of ARMSCOR is here, but  I would like to introduce the topic.  The ARMSCOR Act makes special provision for ARMSCOR to appoint or employ individuals or companies to assist them in meeting ARMSCOR’s objectives which is mainly, ARMSCOR has control over the acquisition development of an acquisition of projects.  The negotiating phase was unique in the sense that we needed Financial Advisors and the decision to select those Financial Advisors was done by the Department of Finance.  The decision to appoint the Chief Negotiator was a decision spelt out in the terms of reference document presented to Cabinet Ministers and recommended by Cabinet Ministers. The decision to appoint a legal firm to complement or supplement ARMSCOR’s Legal Division was won through the ARMSCOR’s Legal Division with four or five companies short listed.  A process of interviews took place and a final selection.  The only area of where we deviated, if we could use the word deviated, is by not putting into the bulletin, the deadline.  The ARMSCOR Act does not require ARMSCOR to advertise its requirement in the bulletin largely due to the fact that this is a Schedule 2 company that is acquiring services to assist itself in meeting its objectives.  The answer is yes.  We complied with the ARMSCOR procedure, but not to its fullest with regard to advertising in the bulletin. - [Mr A Feinstein]  Can I just ask the final question to everybody who is kind enough to appear before us who has been involved directly or indirectly in this deal past and present?  Is there in anybody’s knowledge and we have heard the one instance that Mr Shaikh has indicated, so we take that as given, is there any other instance, any other information that anybody has of any person who has been involved in this process from the Government or Parastatal or Quasi-governmental side at any point in the process, which person or persons might or might not be in Government or the parastatals now, who have interests in or have in the past had interests in any company in any way related to this deal either directly or indirectly? – [Mr H S Thomo]  I am the CEO of ARMSCOR. As far as ARMSCOR is concerned, what we have is we have asked everybody to declare their interest in writing and then subsequent to that, those documents were looked and based on those documents, I mean everyone in ARMSCOR, I can say I have got no knowledge of anyone in ARMSCOR who has got a conflict of interest as far as these packages are concerned. – [Mr A Feinstein]  It would be of value to us to receive those documents to have a look at it if we could. – [Mr H S Thomo]  Is it documents for everyone or just what the document looks like? – [Mr A Feinstein]  If you wanted that document to be restricted in any way you could certainly discuss that with the Chair of Committee.  I would assume there are ways of some documents not having to become public documents at this point. - [Chairperson] Is it a standard document that everyone signs?  – [Mr H S Thomo]  Yes, it is a standard document. – [Chairperson]  Well, you can give us one copy and perhaps a list of your officials who have signed that document and we will treat it confidentially. – [Mr H S Thomo] We will do that.  – [R Adm C Howell]  I feel that as the Senior Navy Officer that was involved from the beginning, I must say to the best of my knowledge all my Navy personnel that were involved had no conflict of interest. – [Mr J Naidoo]  As the person as Head of the Negotiation Team I can say that apart from Mr S Shaikh who had reported that he recused himself from the discussions around the Corvette and the combat systems as a result of his brother being involved in the ADS, no one else declared any conflict of interest. I am not aware of any conflict of interest that anybody else has had. – [Mr A Feinstein]  Chair, the question went a little beyond this conflict of interest in the immediate timeframe of the deal. and I was also asking someone slightly different and that is whether anybody who has been involved in the process of the deal at any point might now, post the deal, have any interests in companies in any way related to this deal, rather directly or indirectly.  So going beyond that immediate period as well. – [Former Chief Executive of Armscor] While I was Chief of ARMSCOR and left them in November last year.  From my side during the negotiation period I had absolutely no conflict of interest or interest in any of the prime contractors, but subsequently to leaving ARMSCOR, I have been involved in the Submarine Consortium in looking at assisting their ambaries Airospace systems and looking at the industrial participation interest in South Africa, but nothing to do with this or any military context with them whatsoever. – [Chairperson]  So are we getting a unanimous no to that question?  – [Brig Gen O A Schur]  I can also confirm that from the Air Force side that there was not a single member of any of the evaluation teams who has had any conflict of interest, both during or after the selection process. – [Chairperson] Members, the Department has distributed this set of documents to us and they have asked us to treat it confidentially. Put it with the other evidence that you have.

Mr B Kannemeyer]  My questions relate to the question of the . I just want to get clarity on the Ministry of Defence’s policy for dealing with the International Defence Equipment Office in the MoD (Ministry of Defence). What Mr S Shaikh earlier indicated on that, that  policy had really been adopted.  Can I just get clarity on that statement?  Is there a policy dealing with this? – [Mr S Shaikh]  That is in relationship to 3.4 in the Auditor-General’s Report. Specific mention is made out of the First-order value system in a MoD work group. What, in fact, transpired was that, in a Council of Defence meeting the then Secretary of Defence and Chief of SANDF submitted a draft document for the Council to discuss and to comment on.  In that particular meeting a decision was taken that is very difficult in a First-order value system to encapsulate government’s thinking with regard to strategic issues and the decision taken was that a listed approach should be adopted.  However, this document served as a draft document.  It was not implemented in the sense that the First-order value system is Government’s input to the direction in which it wants to take the packages.  That was communicated verbally in meetings with the Minister of Trade and Industry, verbally in regard to the meetings of the Minister of Finance and it includes the Minister’s subcommittee.  Those types of First-order value systems may not have necessarily been written down, but they were definitely communicated verbally in meetings.  So the whole issue of First-order value system and the policy document, bear in mind that it was a draft policy document that never was implemented to the letter. – [Mr B Kannemeyer]  Is it correct to say that even though it was not implemented to the letter that if you were to see the responsee adheres or derailing from policy that that would have been the document against which you would measure that? – [Mr S Shaikh]  The documents at which you get your major deviations is the document which the Department called the VD1000 Policy Document on Acquisition Management.  It is spelt out in the ARMSCOR KD100 and it is spelt out in the Department of Defence log pamphlet 2 till 12.  These are procedures and policy documents that tell the Department and ARMSCOR how to do a risk Management Programme.  Bear in mind that when you acquire equipment, these are not ‘off the shelf’ equipment.  It is a document for Engineers and Technicians and Project Officers to follow a process of what they call Risk Management Strategy.  With regard to the workgroups, in fact, what would happen was that the SAFCOM, the Stringency Office Committee meeting, became a workgroup that was an inter and intradepartmental workgroup.  The Arms Acquisition Steering Board became that workgroup.  The Armaments Acquisition Council of Ministers became that workgroup.  The Minister’s working group of the 5 Cabinet Ministers became that MoD workgroup.  So it was not written down that way, but bear in mind that when the policy initiated in early 1997, there was no clear direction as to the receptiveness of this initiative that the Minister of Defence undertook.  So by and large, this happened in conjunction with the Minister of Trade, Minister of Public Enterprise, Minister of Finance and these Ministers then gave high level policy direction on how the workgroups should be then constituted. – [Mr B Kannemeyer]  I am still working from that document.  When this was drafted, as indicated, it stated that several international Defence Equipment offers had been presented to the Minister of Defence and others had been proposed.  Then the next sentence which concerns me is that these International Defence offers falls outside the scope of existing Acquisition Policy and specific Policy for such International Defence Equipment offers had to be established.  Now, an insertion was made here in 1997 that the procurement of these Defence equipment would fall outside the existing Acquisition Policy. I am trying to understand whether you are saying that specific policy was not adopted, because the one that we referred to, I believe is existing Defence Acquisition Policies. – [Mr S Shaikh] Earlier on my presentation I said the initiation of a concept of a package deal was largely something where it came out of proposals from foreign governments which wanting to invest in South Africa and using the Defence Procurement Programme as a catalyst to do that.  So what we said it fell outside the existing procedure where the Department of Defence determines the process whereby which the time scales to acquire these programmes are initiated.  We have adopted the Department of Defence planning scenario with other planning scenarios of Government initiative.  So we terminated the following initiatives and then embarked on a very pure ARMSCOR process of issuing out tenders and then receiving tender documents.  The other approach was, initially proposals came to the Department on package concept.  Respective governments came to the Department of Defence and the South African Government said  we can offer this.  The South African process does not allow us to do that type of initiation.  It allows us to go on tender.  Hence, we have to dovetail that initiative of foreign governments making their unsolicited proposals to us and dovetail it into a normal tender procedure followed by ARMSCOR. – [Mr B Kannemeyer]  In terms of that normal tender procedure then, is that the one where you have a particular sequence in which specific steps have to take place to get to the desired outcome. – [Mr S Shaikh]  Yes, as spelt out in the Auditor-General’s Report in paragraph 3.5. Bear in mind that these policy documents are engineering management documents for risk reduction and the fact that we embark on the following initiative, the risk lies with the following companies and not with the South African Government.  That document, a VD1000 Document, was designed for the time in which local development was the order of the day.  Where as the South African Industries was manufacturing its own equipment within South Africa, hence there had to be a policy to reduce engineering risk to these programmes.  When we embarked on the following acquisition programme, the Policy Document says – there are only two mandatory steps in this entire acquisition document, being the staff target and the acquisition plan.  The rest of the steps have to be adapted to the individual programme per se.  – [Mr B Kannemeyer]  I think that exactly brings us to the second part of this.  In terms of the answers that we have received in response to the Auditor-General’s management letter to the Director-General, there is agreement that for the ALFA (Advanced Light Fighter Aircraft) and for the LIFT (Lead in Fighter Training) projects there were no staff requirement or target at the time where it was supposed to have been there, as well as for the LUH (Light Uitility Helicopter) and the Sub-marines there were no approved staff requirements.  – [Mr B Kannemeyer] If that is correct, then that is the reply we received from the Director-General’s office, why that deviation? If you could just answered that, particularly with regard to the staff requirements was the one area where you could not really deviate from. – [Mr S Shaikh]  We are ready to do a presentation with regard to this. This is a very in-depth complex discussion.  What we are saying is that, ironically the Department of Defence have a staff type of approval for the much more expensive aircraft.  In the Department of Defence planning it became evident that Defence spending was being cut back drastically and the Air Force approval for a much higher aircraft for a billion dollar aircraft system was not going to materialize.  So we had a staff target for the Advanced Fighter Aircraft.  It was modified to accommodate the Defence’s realities at a reduced Defence budget. So that staff target of the AFT, Advanced Fighter Aircraft, was adapted to the ALFA, the Leading Fighter Trainer Aircraft. We use that staff target to assist us with regard to a lower value aircraft and a lower performance aircraft.  Technically speaking, there was a staff target approved for a much bigger aircraft.  We through the Defence Planning decided to cut back on our Defence requirement and our Defence front and fighters programme.  There is a presentation of General Schur.  I would like him to introduce that subject.  It is much more versatile in explaining that question. - [Chairperson]  Bruce, with your permission, could we get a response from the Auditor-General’s Office as to that possibility as explained by Mr S Shaikh. – [Mr S Fakie]  Apparently the information that is given is exactly as we have understood and interpreted it during the course of the Auditor’s role. – [Chairperson]  You are not able to respond to the answer given by Mr S Shaikh. – [Mr S Fakie]  No.  That is what has come out of the Audit evidence. The evidence that we have is exactly the same that for the ALFA the staff requirement was of a different order. The Advanced Fighter Aircrafts was used and that scaled down to determine the staff requirement. That is all I can confirm at this point. – [Mr B Kannemeyer]  One can accept that, but the point is that according to our understanding there should have been a staff requirement or a staff target determination from scratch.  There is admission that that was not done.  Something that was there was just taken and amended to or qualified to suit the needs of probably a particular product and not what was intended. That is what we are trying to get here.         – [Mr S Shaikh]  I would like to request Adm Verster and Gen Shur to introduce and explain those topics. – [Chairperson]  Bruce, how much detail do you think is necessary? – [Mr B Kannemeyer] I am satisfied that Mr S Shaikh has indicated that for the ALFA there was no staff target and staff requirement.  There was an improved target for the Advanced Fighter Trainer that was indicated.  That was amended.  I think that is clearly understood.  As I have said the Committee has got a problem with that, because in terms of Mr S Shaikh’s own indication, the staff target and staff requirements were one of the areas where there should not be deviation from.  In my opinion there was deviation from it, because an existing one that was adapted or changed to fit in with product that probably was available. We would like you to respond to that. -  [Brig Gen O A Schur]  I think just to confirm, the influence that the Staff Target Process was manipulated after receiving specific information, is incorrect.  The Air Force Command Council and the project of  Kosi Steering Board, first of all we viewed the requirement of the Air Force in terms of its reduced requirement for a balanced pilot capability which was vested in the risk and the ALFA concept and from that they agreed to specific levels of performance and functionality that had to be included, that are the gist of the staff target. All of this was minuted in the Air Force Command Council, as well as the project of the Control Board Meetings. The launching of the LIFT process, the whole process was preceded by the approval of the joint staff target and staff requirement in April of 1998. – [Mr B Kannemeyer]  With regards to the submarines as well as according to the Auditor-General’s Report again, the Council of Defence concurred that for the submarines there were no approved staff requirement.  There was only an approved quorum for the upholder. Also to suggest that there has been deviation from that was indicated to be the agreed process.  Would that be correct? – [Mr S Shaikh]  We would like to state that is incorrect.  The documents provided to the Members,  under paragraph 3.5.  Admiral Verster will give you a much more detailed explanation. – [Mr B Kannemeyer] I am prepared to accept the answer.  I would just like the Auditor’s Office to comment on that, because we are preparing on the basis of the management letter between the Auditor-General’s office and the Department.  In the response we got from the Department, the Department concurred. – [Mr S Shaikh] The staff target was approved as indicated in the document on the 9^th December 1995. – [Chairperson]  Do you want a response from the Auditor-General’s Office, Bruce? – [Mr B Kannemeyer]  If they could, it would be helpful. – [Mr S Fakie] I can only go by the response that we have received in the management letter which in actual fact the Department concurred with our finding. The upholder baseline was superseded when upholder was withdrawn, leaving the staff target as an approved baseline.  It had previously been approved by the DCC on the 9^th December.  So, basically, what we are saying is that for the submarine programme itself, the approved staff target was not there and it was something else that was used for that purpose.  I think the response actually concurred that that was the situation.  – [R Adm B W Visser]  Can I enlightened that a little bit.  As we said there are two mandatory documents in the policy, a Staff Target and an Acquisition Plan.  I can  assure that in all respects there were staff targets and acquisition plans at crucial points for every programme.  However, in terms of the upholder, it needs clarification that the staff target contains, and I would read for you.  “The required operational capability defined as a capability and not in terms of a hardware or technological solution.  In other words, the staff target should not be written for an upholder.  It is written for a required capability”.  Therefore, I think there is some misconception around the staff target for the upholder.  The staff target was for the submarine capability.  It should have been that and if mention was made in the staff target, which was quite possible of an upholder solution, that is wrong.  That we concur is wrong.  There was a staff target for a submarine capability and that was what was required.  I can elaborate on that.  I have got a transparency to show you datelines of all these, but I think that might be too detailed for the Council and I would submit that I give it to the Member that has an interest in this to study this in detail. – [Chairperson]  If you can pass that on to Mr B Kannemeyer, thank you. – [Mr S Shaikh]  Admiral Derek Dewey has been liaising with the Auditor-General’s Office in compiling the response.  I would like him to respond. – [Brig Gen A R Cumming]  We concurred on the finding.  There was not a staff target for the submarine in the sense that in the preparation for the Strategic Defence Package Project baseline documents, that master document dated 1995, did not specifically lead to the decisions related to the submarine in the Strategic Defence Package Project.  As already mentioned, what followed the 1995 staff target was an upholder version.  When the upholder was no longer considered between the RFI phase and the RFO phase of the evaluation, the previous requirement of 1995 became extinct. The upholders requirement was then withdrawn.  This development of requirements takes a long time in such a complex process as the acquisition process that we follow.  It takes years to develop a requirement to reach maturity at which point we can concur.  The example is very clear when one considers the development of the baseline for the Corvettes. It started in 1980 and it only came to maturity at a decision in 1998.  I hope that clears up that point. – [Mr B Kannemeyer]  I think I have got to rest with that one. My next area relates to the tender procedures and the subcontract in part during the negotiation phase. As ARMSCOR was required to place the contracts and eventually had to pay for the work performed or committed, the IRNT should have followed the ARMSCOR tender procedures.  From correspondence it is indicated that there were indeed deviations from the ARMSCOR tender processes as well.  The question we are concerned about is whether the possibility because of that does not exist, that certain persons might have been prejudiced because these tender procedures were not followed. – [Mr S Shaikh]  The deviation in so far as the tender procedure, applies only to the advertising in the bulletin.  It is not mandatory for ARMSCOR to advertise in the Bulletin services which it requires for itself.  ARMSCOR’s primary job is to acquire on behalf of the Defence equipment.  All equipment requirement goes into the Tender Bulletin.  Services that ARMSCOR requires for itself, internally, does not necessarily have to be in the Bulletin.  The difficulty that we found in the negotiating phase, it is very difficult to put in the Bulletin the Chief Negotiator required and to describe his details. We would have had every arms dealer wanting to take over Mr Naidoo’s job.  What we have looked at in discussion with the Ministers, nominated someone for that particular post with regard to the Department of Finance selecting the best bank or institution that can assist the Department of Finance in its discussions and negotiations with the suppliers. There was a process of recommendation and evaluation undertaken by the Department of Finance.  That name was forwarded to ARMSCOR.  ARMSCOR forwarded it to the ARMSCOR Authorisation Committees. It duely went to the ARMSCOR Board for final approval and ratification and the Minister’s Committees was notified of the selected tenderer for that particular service.  So with regard to the process, it was complied with, except the provision of tender, but there is no mandatory requirement to introduce that element into the tender document. – [Mr H S Thomo]  From ARMSCOR’s point of view, the appointment of the Legal and Financial Advisors that were advising the negotiating team and the selection of those Advisors, I believe the negotiating team has gone through a process to do that. Like the Auditor-General says, the payment has to be done through ARMSCOR, because the contracting that is done by the Department of Defence is done through us.  – [Mr B Kannemeyer]  That is exactly the concern that the payment and everything is done through ARMSCOR, but ARMSCOR’s process is said to seem not to have been followed.  In terms of the replies that this Committee has received on some of the answers that were posed by the Auditor-General’s office, there seems to be a disjunction between what the replies that we have received and the answers that is forthcoming now, as was the case with the previous question that I have posed as well.  What is the actual position in this regard, because even though it is indicated that processes were followed in the response to the management letters that questions that were posed, it is indicated concurrence that the DOD’s Director-General indicates that they concur with the findings of the Auditor-General. – [Chairperson]  You are quite correct.  There is inconsistency between your replies. – [Mr S Shaikh]  When we first embarked on the Auditor-General’s request to conduct such an audit, it was followed at  the Minister’s Committee and an approval was given in principle setting out the terms of reference.  In discussion with the first meeting with the Auditor-General and the Secretary for Defence, we spelt out a programme whereby there will be three meetings to take place, An audit finding, the Department of Defence will be given a response and a process whereby the final report would be discussed on the level of the accuracy.  Two meetings took place.  The third meeting did not take place.  I have a letter given to me from our Department of Finance.  The date the Department of Defence up until the 28^th September to complete its response.  In fact, the Auditor-General went public two weeks before that date with the result.  So we were not given the opportunity to correct that.  There were interpretational issues with regard to the staff target. We were concurring on principles other than what the Auditor-General wants. Hence we had no opportunity to agree or disagree on the final Report or to present our case accordingly. – [Mr B Kannemeyer]  Those areas which are indicated, is that contained in this package of documents that has been forwarded to us? – [Mr S Shaikh]  Yes. All responses to the Auditor-General is now forwarded.  It is unfortunate that we had to do it in this particular way rather than been given the third opportunity as spelt out in our agreement with the Auditor-General. – [Mr B Kannemeyer]  Can I just ask the Auditor-General’s office to comment on that? – [Chairperson]  Mr van Heerden has indicated he would like to respond. – [Mr Van Heerden] The reference in the Management letters was made in respect to three contractors.  One is the Weber Contractor, the White and Case and also one of ………………..  as well as Leeworld Investments.  Now according to our management letters we indicated that although ARMSCOR had to pay for these services, the tender procedures of ARMSCOR was not followed. The DoD did conclude and concur with our findings and it is also confirmed, and I would like Mr Pier Hoffman, if he is present, just to give us an indication on exactly what happened during those processes.  – [Mr B Kannemeyer]  My question was actually on the point that Mr S Shaikh has made that there is an agreement that there would be a last meeting to check the flow of information.  If the Auditor-General’s Office would like to respond on that.  – [Mr S Fakie]  There was an agreement that we would agree on the factual correctness of the findings with the Department. We did not have the final Steering Committee Meeting but we did in writing on a number of occasions forward the letter to the Department and, to my opinion we did give them sufficient time to respond to all our inputs.  We did take all the inputs into consideration in the Final Report.           – [Mr S Shaikh]  The Auditor-General’s Act says that the Secretary of Defence, being the Accounting Officer, should get a draft or get a Report 7 days prior to submission to Parliament.  We did not receive such a draft, hence we were not in a position to comment on such a draft.  There were a lot of discussions between, not the Auditor-General but the Auditors and the Department of Defence.  We were discussing with Audit firms, not with the Auditor-General’s people.  We had only two meetings and we are hoping to have a third meeting to clear up these discrepancies with the Auditor-General’s staff.  We were having a lot of discussions with private companies which are Auditors. – [Chairperson] Just as far as you were dealing with tender procedures, perhaps you can give me a legal opinion whether the agreements with the Prime contractors, were they a contingent on those tender procedures having been properly followed and followed in a way that there was fairness to all bidders. – [Mr S Shaikh]  The contract that we have with the bidders that we sign contracts is under the auspices of the ARMSCOR Act where provision is made in the ARMSCOR Act that ARMSCOR is the sole agency to sign that particular contract with the respective suppliers of equipment.  Again, this was a unique endeavour in the sense that the NIP agreements had to be signed with the Director-General of DTI and the respective bidders.  The finance agreement had to be signed with the Minister of Finance and the Director General from Finance with the respective bidders.  In so far as your questions, I am not so sure if I have answered them correctly. – [Chairperson]  Perhaps not altogether.  If it were to be discovered that there were irregularities in the tendering process and in the Tendering documents and if parties were prejudiced in any way, would that be grounds on which to cancel contracts?  – [Mr S Shaikh]  Provision is made in the tender documents in the event of bribery, that that contract will become null and void.  It is written into the contract. – [Mr J Naidoo]  I may have misunderstood the point.  I think the Report of the Auditor-General which covers the contract for tender irregularities refers to those contracts that were put in place in order to establish the resource base for the negotiating team which was an extraordinary procedure but in terms of the nature of the job, it had to be done under ARMSCOR.  So there was a disfunctional connection between the interdepartmental decision making procedure and the contracting paper work.  That did not have any connection, in my opinion, with the contracts with regard to the tender list, the Defence contractors that eventually won this.  – [Chairperson]  I was not suggesting that connection.  My question did not arise out of the Auditor-General’s Report.  – [Mr H S Thomo]  I just wanted to say that these contracts for the consultants came after the decision has been made  in terms of who were the preferred bidders.  So, they would not have any material influence on the main controversy.  – [Ms N Hlangwana]  My question is in relation to the Corvettes. A local company has prepared certain technology work on behalf of the SANDF funded by a previous technology retention project.  The SA Navy indicated that it preferred the technical potential offered by a local company.  Maybe I can refer you to page 5 of the Auditor-General’s Report, paragraph 3.6.1.  The potential offered by a local company in respect of the integrated management system of the Corvettes.  A French product was chosen on the basis that the aforementioned was outweighed by the prohibitive risk driven cost indications. Why was the subsystem SJT developed for the South African Navy and paid for by the DoD and ARMSCOR not prescribed for the Frigates? – [Mr S Shaikh]  The issue of conflict of interest, I have answered the question noting the conflict of interest and I have asked the Navy Captain on the programme to answer the question.  In so far as the Navy preferring such a system, in your documentation handed to you is a letter from the Chief of the Navy saying that it is factually incorrect.  The Navy did not prefer that system.  In so far as the Navy jointly developing this technology, this technology belongs to the Navy.  The Navy did not want to assume the risk of this technology because it is not a product and the policies in the Department of Defence says very clearly, that if you have a very integral technology in a big system, you have to freeze that programme, complete the technology development, make sure and prove that it works before you can incorporate that technology into the programme.  That meant that the Navy had to freeze its acquisition programme yet again for the Corvette, as you have heard it started off in 1980, freezed with the opposition of the Corvette, develop this unique technology that in fact it is a technology and not a product and incorporated into a ship and then tested on a ship to see whether it works.  The technology in concern is the heart of the system.  It is the nervous system of the entire ship.  It connects the weapon systems.  It connects the radar and communication systems, etc.  The risk was considered by the Chief of the Navy and his team to be of a high magnitude and the cost of the programme, being R30 million of the product, and the cost of the programme being R6 billion, there was no justification to put at risk the R6 billion project for a R30 million technology.  That decision was taken by the Chief of the Navy who chaired the meeting on the Project Control Board with the approval of his Naval Command Council.  The risk was asked to be carried by the supplier of that technology who did not want to carry the risk, neither was the State prepared to carry this risk.  This matter was taken all the way up to a Cabinet Committee level.  The Cabinet Director, the negotiating team, not to assume this onto itself or the State for the detriment of the State.  Hence, neither the German Figured Consortium were willing to carry the risk.  The risk in so far as money is one element of risk, it is a risk with regard to time, it is a risk with regard to performance.  There is risk with regard to performance, risk with regard to would the supply be around 10 years, 15, 20 years from now where the ship has to last a 30 year period.  So there are many elements of risk.  That risk, the Department of Defence through the Chief of the Navy did not want to assume.  Attached to your documents handed to you is that issue of risk?  I would like to ask if there is any firm elaboration that Captain Kamerman can make to that statement.  Added to your documents given to you is a letter from the CEO of the local company who accepts that his product is still a technology.  He needs an additional R15 million before he can make it a product.  He further accepts that there is a risk of 35% on his own product.  He further emphasized in his own letter that for the Navy to have peace of mind, that we should transfer these risks from his company to African Defence System.  Well neither African Defence System, nor the  German Figured Consortium, nor the  Chief of the Navy were willing to assume that risk which was fundamental to the operating of the ship.  We are acquiring a R6 billion ship and at risk to the R6 billion ship is the technology demonstrator. – [Ms N Hlangwana]  What I was going to ask is that because of paragraph 3.6.1 in the Auditor-General’s Report, maybe the Auditor-General would like to make a comment because my understanding would be that his information is based on the Management letter that should have been received from the Department. Maybe the Auditor-General would like to comment on that. – [Mr A Feinstein]  I am not sure if it is in this pack of documents that we have just received.  I have not had a chance to go through them.  I have been referred to the document entitled “SA Navy Patrol Corvette Combat Suite Element Costing and Description - the status of which is authorized for issue on patrol Corvette Acquisition Project”.  It is signed by Captain JEG Kamerman on the 28^th January 1998 on behalf of the Chief of the SA Navy and it says, amongst others, the vessel contractor will be a teaming arrangement between the ship platform supplier and the nominated RSA combat suite supplier with subcontracts placed on nominated companies for the various subsystems and these are all listed in the Appendix to this document.  I am not sure but it seems to contradict somewhat the reply that we have just heard. – [Captain JEG Kamerman]  We must put this in the context of the time line of the entire tender process.  The document to which the Honourable Member is referring which he correctly indicated was generated by the project team for the Corvette, was the document to enable the tendering for the prime contractorship.  That is with respect a one annexure of a very large request for offer wherein there is clear indication of how the tenderer should treat that particular document.  It is very clearly indicated elsewhere and reference is made in the submission we have made today to the related documents when that particular document named by the Honourable Members is called up.  In short, the tenderers were obliged to offer a tender which included a variable of his particular vessel or the platform, the ship itself, and a generic exactly similar combat suite for each particular vessel.  The reason for that of course was the fact that we wanted to drive out the best platform amongst the various shipwrecks.  So we reserved the combat suite, if you will, in a box completely sealed.  It had a fixed price with no request, in fact, an injunction specifically not to quote on the combat suite and the list of so-called nominated suppliers, if the Honourable Member will turn to the particular Annexure, you will see that the entire combat suite is listed as “nominated” and each particular supplier is listed as an intelligent supplier.  That particular list of suppliers arose from the local industrial base on the one hand and on the other hand from a list of potential suppliers of overseas equipment that we already knew that we did not have the potential locally to supply that equipment.  Subsequent to that, when we went out on a request for offer and subsequent to that particular pack, the request for offer went out on the 13^th February, received in July and subsequent evaluation leading to the selection by the Cabinet of the main contract, in this case the German Figured Consortium.  In the June/February Consortium’s bid, as in all of the tendering bids, that is from the various countries bidding for the main contractorship, they all understood exactly the same thing and they replied accordingly.  The combat suite was not quoted for.  The only reason that that particular list was generated as is made very clear in the pack, was to enable us to evaluate a common combat suite that would not be a variable.  Subsequent to that, the preferred bidder in this case the German Figured Consortium was given instruction to bid on the combat suite element. That is contained in the RFO  process as well if one reads the accompanying documentation which is not being referred to unfortunately. - [Mr A Feinstein]  I do not have some of the aspects that I am being referred to here.  I just have a partial document.  But it seems to me that at one point there was a document submitted that said do not tender for this aspect, close it off in a box and there were various nominated suppliers listed in the document and then down the line, the same people for whom this document of which I only have fragments, was prepared were told do bid for it. Is that correct? – [Captain JEG Kamerman]  ]  The unfortunate thing is that it is a fragment of a formal request for offer that went internationally through the Embassy.  If one reads that entire pack, which you are at liberty to do, it is available.  We will certainly supply it within a day.  It is clearly indicated what the future strategy of tendering will be and it is categorically stated that the future strategy will be that is to tender for the platform or a fixed generic combat suite and once he is selected or marked as the case may be, once he is selected as the prime contractor for the vessel, then negotiations will be entered into by himself against a user requirement specification which in fact was the case.  In the user requirement specification, if you will, which was sent out with the injunction from the state or the directory from the state, in fact, now tender for the combat suite.  The said company was listed very categorically as a candidate supplier, not a nominated supplier as were all other local and overseas candidates. There was no prescription of any particular company during the bidding process. – [Mr A Feinstein]  There is a bit of confusion around this.  What would be very useful is if we could get the full document and look at this issue or just this aspect of it. – [Chairperson] Could I also add that the Managing Director of the local supplier is here with us today and has sent me a note expressing his objections to references, to paragraphs of his correspondence, which he, I think is suggesting are out of context. Perhaps if you want to quote, you should quote the whole letter.  So it seems from both sides we need to have a fuller look at the documentation.  I think from a Committee’s point of view, our interest here is obviously that a selection of a South African company and the economic spin-offs of something that we would regret not having taken place, but perhaps there is good reason for it.  This is obviously a matter we will pursue further. – [Ms N Hlangwana]  We still owe it to the Auditor-General to respond. – [Mr S Fakie]  There is a bit of confusion on this statement and as to whether this concurrence on this statement of the local supplier.  The statement that we have made in the Audit Report comes exactly verbatum from the response that we have received from the Department.  What the Department has indicated to us is that the SA Navy expressed an overall preference on the system but they conclude by saying that it would be correct to say, this is a response from the Department, It would be correct to say thus that although the SA Navy preferred the technical potential offered by the C1, C2, I2, this was outweighed by the prohibited risk factor.  This is exactly verbatum what we have quoted in our Audit Report.  So, I get the impression that maybe the SA Navy did not express overall preference but on the technical aspects they have.  That is where we got our findings from the Auditor’s Report is out of the response to the Management letter. – [Mr S Shaikh]  In our second meeting with the Auditor-General, we made it very explicitly clear that the Navy did not prefer that.  If you are talking from a technological point of view, does the local technology offer potential.  The answer is yes.  But is it the product that the SA Navy wants at all costs against risk – the answer to that is an emphatic, no.  Now that is the response in discussions when we had the Auditor-General’s staff.  In our second meeting, the staff indicated they understood that concept of what we were trying to put forward.  Hence, by missing the third meeting, there was no way of us to bring together our different views.  In the presentation that we did in the second meeting, we made it clear, and the Auditor-General staff indicated they understood what we were trying to say and that is not an issue that they think would be something that will result in our Report.  We found, it was different when the Report came out, because now there is a direct inference to that meeting and to the issues that we presented.  If the Chief of Navy was asked an emphatic question “Do you want the local product against all risk?, the answer would have been a definite no.  Do you think the local product has potential? Yes.”  Such is the nature of technology.       – [Chairperson]  We must not play with words here.  I just want you to confirm your words here which say “the SA Navy preferred the technical potential offered by ……..  Is that a correct statement? – [Captain JEG Kamerman]  The question here is a technical one of course.  I do not propose that we discuss the benefits of different technologies to distribute data in the combat suite and border. – [Chairperson]  I’m asking for a Yes or No answer.  What you have written here, do you stand by it or don’t you? – [Captain JEG Kamerman]  The word is potential, not the solution. – [Chairperson]  No, the word you have written here, you preferred the technical potential opened by …….  Do you stand by that? – [Captain JEG Kamerman]  The potential of the BUS, because the potential of the BUS is the future technology. – [Ms N Hlangwana]  A risk premium of about R40 million was added in respect of the local product for the IMS.  Why was the basis of the calculation of the risk premium by the prime contractors not properly evaluated by DoD?  Were risk premiums added to any other products? – [Mr S Shaikh]  The risk premium with regard to R40 million is as pertaining to the cost element and not time lines, etc. which we have indicated is performance risk and time risk, etc.  The R40 billion risk, I would like the Project Officer to explain the make-up of the R40 billion risk. – [Chairperson]  Nomvula, couldn’t we ask for that in writing?  I think it will be the types of figures and calculations that we would like to study to see how they go about calculating that R40 billion risk.  Would you mind if we got that in writing? – [Ms N Hlangwana]  Can we get it in 7 days? – [Mr S Shaikh]  Yes, but bear in mind that the issue of the risk addition is not something we interrogate the prime contractor on.  We either accept it or we reject it?  But we will give you the breakdown of that. – [Chairperson]  Then the second question asked by Ms N Hlangwana? – [Mr S Shaikh]  Yes, with the other risk premiums, I can come back to you to find out which programmes had risk premiums.  It is something I do not know off hand. – [Captain JEG Kamerman] We have seen that there is a very large portion of the risk, one other particular programme is the local Cape Town Service  …………………… which is a fairly substantial, in this case more than R50 million added for risk proportionate. In that particular case that risk was added by the Management of that particular company, in this case, Kentrom, and added to their price.  We thought that was a fairly reasonable addition considering that System 2 has somehow risks involved in its delivery. - [Ms N Hlangwana]  I think if we can get a written response on all the products that take risks. There was an instruction given by ARMSCOR to any other organization to prepare alternative offers for the Corvette combat suite.  If so, full details of such requests or instructions are required. Why was such a request made and when was the request made? – [Mr S Shaikh] I can check with regard to alternative offers for all other programmes.  With regards to the Corvette programme, when we went out with the best and final offer, the price that came back far exceeded the Government approved ceiling baseline by the magnitude of twice the price.  ARMSCOR as per Government Director with regard to the price of the overall ship was mandated to stay within the price had no mandate to lift the combat suite price by times 2.  An instruction was given by the CEO back again to the German Figured Consortium, that they have to stay within the Cabinet approved sealing price, even if it means alternative suppliers and systems were proposed.  The guideline there was priced in order not to lift the price ceiling in negotiations. Subsequently, negotiated the tender price down from the initially agreed tender price, so the State can take a net benefit.      – [Ms N Hlangwana]  Did any Covertte Project officer ever undertake a price audit?  If so, what was the price audit figure for the project and particularly what was the baseline price on the request for order for the Combat suite?  Was the offer made below or equal to the request for offer baseline?  If not, can we get full list of the difference. -  [Mr S Shaikh] I would like the Project Officer to respond to that.  Maybe some of the information is not available right but we can provide it to the Members later on.  – [Captain JEG Kamerman]  On project Citron, which is the acquisition of Corvettes for the South African Navy, we follow the standard tender process and the subsequent negotiations with the selected supplier.  During that process of course our daily activity was auditing and making sure that the various prices were coincident with what we have been offered and tracking those through the negotiation process.  I think you may be referring to budgetary estimate audits that were being carried out on the Technology Retention Programme which preceded this particular acquisition.  The technology programme, called SUDECX, was to retain the local industrial base to as far as what is feasible in order to support the Corvette Programme.  Audits certainly were carried out there. Audits in the case and not an audit against any particular baseline but they were, in fact, budgetary estimate calculations.  So that we have an order of magnitude idea of what we were to expect doing a tender process.  At that stage we know budgetary estimates were carried out.  They were not in any way audits.  When those budgetary estimate activities were carried out they were done significantly preceeding any tender processes for these Corvettes.  In fact, it was approximately a year before that we had.  So the entire exercise that you are referring to, I believe, was an exercise to derive budgetary estimates only.  Those estimates have had no status during the tendering process other than providing us with some degree or order of magnitude of what a modern combat system for the Corvettes would cost. – [Ms N Hlangwana]  Can we get that in writing? – [Captain JEG Kamerman]  Certainly Honourable Member.  – [Ms N Hlangwana]  Why did the DoD not take responsibility for the risk of the local company? – [Mr S Shaikh]  The risk for this technology is not the R20 to R40 million risk that you add.  It is the risk of the entire ship that is at stake.  In order to secure performance guarantees, the state has to get performance guarantees for the entire ship, not for the entire sub-system offered.  We had to get the performance guarantee of the entire ship.  When we secure the performance guarantee of the entire ship, we had to get the following countries to give us an export guarantee.  That export guarantee allows the Department of Finance to borrow money at a much reduced interest rate.  At risk is not just merely the R30 or R40 million added to that.  It is the entire risk to the State with regard to an extra 2 to 3% interest with regard to what the State would have paid in the financing.  The lack of no foreign guarantees with regard to the export guarantees, the lack of not getting a performance guarantee for the entire ship and that the foreign supplier was telling us, because this particular project or product was central to the entire functioning of the ship, the guarantee issue was paramount.  - [Captain JEG Kamerman]  The first issue is one of what is the IMS insisting and that we have already explained.  Just to conclude from a Naval point of view or a management point of view, the IMS is a sub subsystem of the combat suite which in turn is a sub system or system on board the ships.  The IMS is a critical Level 2 component, we are contracting at Level 5.  But when I say critical component, if the IMS, which is literally the spinal cord of the combat system on board fails, it will have the same effect of the failure of a human spinal cord.  In other words, the entire combat capability, in fact also the safety issue was in total jeopardy.  So that particular component is a critical component of holding the main contractor liable at the vessel level of the total ship level in other words for the performance of the ship.  It was not an acceptable scenario to even consider undertaking risk of that nature with regard to allowing or prescribing a sub sub subcontractor to the main contractor who would then establish liability for the rest of the professional level.  We are not prepared to do that, in fact, we are not mandated to that.  We are mandated to do exactly the opposite.  The truth of the Navy itself expressed this very strongly in the letter which has been submitted as part of your package. – [Chairperson]  I do not need much more than a yes or no answer.  The French company that ultimately got the deal, did they have any relationship to the prime contractor? – [Mr S Shaikh]  They are nominated by the prime contractors? – [Chairperson]  Any equity relationship? – [Mr S Shaikh]  I am not aware of that. – [Captain JEG Kamerman]  The company in Texas is a company of Thompson NCS of France and Thompson is one of the consortium partners. There is no relationship at the time of the bidding between the company Texas and the German Figured Consortium through whom the tendering for the combat suite was done.            – [Chairperson]  Are you saying subsequently that the prime contractor brought this subconctract?  Is that what I am understanding? – [Captain JEG Kamerman]  No, the prime contractor for the Corvette is not Thompson, the prime contractor for the Corvette is a consortium of companies – German companies, French companies, South African companies.  So the consortium itself only exercises any relationship with the Texas company through one of the consortium partners that is Thompson who owns Texas.  It used to be owned by Disult and they sold it in 1997 to Thompson.  – [Chairperson]  The technology that we required here, is it considered to be modern technology? – [Captain JEG Kamerman] It is of the most modern technology available in modern combat systems.  It is the most modern combat IMS system fielded to date.  Apparently, on the brand new French Nuclear Carrier, Charles De Gaulle and on both of the newest programmes currently built in the world today. – [Chairperson]  Did ADS or FBS play a role in securing that subcontract? – [Mr S Shaikh]  The answer is an emphatic no.  This issue had everything to do with proper risk management.  – [Ms Modise]  I am a little bit surprised because when I was in France I went to Thompson and they told me that what we are buying is not the latest technology.  You are saying that it is the latest technology.  While we originally put money, as DoD, into the development of IMS and how much of that money is, why we would go and distance ourselves from it, if we are, how do you develop a capability? Some of us have been preaching about ensuring that South Africa develops and retains capability.  Now there is an opportunity to do so.  Then we walk away from it.  We walk away from it and we get a ship that is foreign built.  The combat suite which is not going to come from a South African company, and the subsystem which is also going to be foreign.  What is South African in the Corvette? - [Mr S Shaikh]  The programme in which we undertook previously with regard to Acquisition Management where South African Department of Defence took the entire risk, resulted in a ship, if we follow that approach, not being R6 billion.  He would have finished off at R7 and R8 billion.  Now we have decided through the Department of Defence and through the Ministers process to use this process as a cealing price.  Most countries around the world will assume the risk thus resulting in the cost of the overall equipment incrementally increasing due to the risk factor.  We decided to have a cealing approach which means – do not carry risk, do not let the project creep, because you have technology gaps. So we have decided not to do that.  It is cheaper to have a sealing price.  Do not try to reinvent technology that exists out there. – [Captain JEG Kamerman]  With your question regarding to the response you received from the French.  I do not understand their response except in the context that, of course, any fielded technology is never the latest leading edge technology.  In this particular case neither was the alternative option being proposed by the local supplier.  The leading edge technology by its very nature is risky and is never really a product until it is fielded, in our case, normally by large donations. I can give you assurance again that the combat management system and its associated Information Management System is the latest technology available today.  It is not the 1960s technology as has been recently read in the international media.  The second part of your question, if I could remind the Members that the developments that took place in the local industry after the deferral of the Corvette Programme by Parliament in 1995, were critical to the current Corvette specification and the current Corvette contract.  In fact, they resulted directly in more than 60% of the current Corvette combat system coming completely indigenously.  One very small part of that was the development technological retention programme. The aim of that technology retention programme was precisely to attain the local base to enable small companies such as C2I2 to survive and then to utilize their services as feasibly as possible there after.  In this particular case C2I2 did survive.  They are employed not only on this programme using their technology base in the Corvette Programme, as well as critically on the software development of the Submarine programme.  In the Corvette programme they have a significant contract to supply their navigation distribution system.  They are also critically involved in the software development of the machinery control system.  So in fact, our investment in technology with C2I2 during the technology retention project is in fact being realized right now.  Unfortunately, we were not able in the risk scenario attendant with his particular IMS subsystem to enable the particular technology product that was arising at that time, it is still not been developed in the full product to be included in the Corvette. – [Chairperson]  The last area we are going to cover concerning the LIFT programme. – [Mr S Leeuw]  It is clear that the Department do not stick to the policies they have adopted themselves.  The very same questions that I was going through is in relation to the LIFT programme.  Could you please explain the details why the Armament Council, after agreed on a certain criteria and then suddenly they changed during the implementation of the process.  That is, excluding the cost factor into the whole formula whereas they have agreed prior? – [Mr S Shaikh] That paragraph that makes reference to the Armaments Acquisition Council which is really chaired by the Minister, the Chief of SANDF, the Secretary of Defence and the Chairman of ARMSCOR, in the RFI there is a request for information short listing phase.  Because the Air Force selected one aircraft from a cheaper cost category and four aircrafts from a high cost category set the basis of the tender to go out would be immoral in the sense that there is an out right winner even before you even go out on a tender.  The cost factors are times 2.  The operational requirement is different.  One has dual capability.  The other has a single training capability.  In that form it was suggested that cost, if that is how the repress from the Air Force should be to shortlist, taking one for one cost category and four from the others, then cost should not be considered as a limiting factor because you are then going out with an abnormal tender.  Now, the Project Team was supposed to incorporate the Council’s recommendation into their value system.  They did not do that initially.  They received the tender documents.  They did the evaluation.  They went to the Air Force Control Council and it was pointed out at the Air Force Control Council that the higher body’s recommendation should be incorporated.  This was a technical evaluation.  That has happened before, largely due to the fact that the Air Force requires to pull out the military technical performance of the aircraft excluding the cost parameters.  The Air Force Command Council requested that the issue of price should be considered and a costed and non-costed option should be presented.  It went from that Forum into what we call the SAFCOM Committee which co-ordinates the technical value, the NIP value, the DIP value and the finance value.  So it was way before the Air Force even know what is the overall score and it was then presented to the Armaments Acquisition Standing Board, which is again a DG and DEG forum and it was requested that this issue of costed and non-costed issue direction is specifically required.  The decision taken by the Chair, who was then the Secretary of Defence, indicated to the SAFCOM team that they should go to the higher body, which is the Armaments Acquisition Council for guidance.  It was duly done.  At that meeting, the Armaments Acquisition Council referred the matter to the Council of Defence.  Again, explicitly requiring what to do with the costed and non-costed option.  At the Armaments Acquisition Council, the decision was taken to take this matter to the Minister’s Committee.  This matter was taken to the Minister’s Committee, debated at the Minister’s Committee.  The issue of the price variants was discussed at the Minister’s Committee.  The issue of the Air Force preference was discussed at the Minister’s Committee and a decision taken there. – [Mr S Leeuw]  When you sit down you develop a criteria or a policy that this is what you want.  You go out there and you put it on the tender.  Obviously, if a person does not meet a criteria of what you want, then the criteria will guide you, but here you change the criteria to suit the people who are bidding. That is the problem. – [Mr S Shaikh]  No.  The value system is not known at all to the bidders.  That is an internal document that the Project Team and the Air Force hold.  That information is not known to bidders.  So the bidders have no idea what we evaluate in the product against. – [Mr L Chiba]  Actually the evaluator knew the criteria.  You are saying the bidders did not know the criteria. – [Mr S Shaikh]  No.  I said they do not know the valuation point scoring system, that is the value system that they are evaluated against.  They have no idea of that.  What they know is our user requirement statement against what type of aircraft we want.  They do not know the evaluation and the point scoring that we attach to such a user requirement statement.  If I may add, that information is locked up in the ARMSCOR Procurement Secretariat and it was only opened when the Auditor General’s team came to inspect it. – [Mr S Leeuw]  Was any formal extension made to the technical value system for the LIFT programme in respect of adding a non-cost base value system in addition to the cost base value system? The third one leading to the various questions are whether there were any similar additions made in respect of the technical value system for other project and if not, why not? – [Mr S Shaikh]  I would like to take the second part first.  The Air Force Programme on the LIFT was unique in the sense that no other programme had such a cost variant and I use the word – times two. In the case of the Air Force LIFT programme,  the shortlisting were what with one cost bracket of roughly R2,5 billion and the other was on R4,5 billion.  In no other programme was the variants between the price so large, times two.  In the LUH programme, the helicopter, the ship programme, the variance is about roughly between 5 and 10/15%.  In that case you can then evaluate one product against another.  When the cost variant is so large, you cannot evaluate one product against the other.  I would like the Air Force to comment further.  – [Brigadier General OA Schur]  Also just to add to that, the original value system that is drafted to analyse the RFO was approved in April or 1998 before the RFI information had even been received.  Subsequent to the RFI information, and having been evaluated and having been presented to a joint AASP and AAC forum, the Minister of Defence as the Chairman requested that the Evaluating Team should consider looking at an option that is costed and non-costed to ensure that the actual performance differences between the low cost aircraft versus the higher cost category aircraft, could be adequately evaluated.  This was not made known to the Project Team and therefore they prepared an initial costed option only.  When they presented their findings to the Air Force Command Council as the first sifting forum, the Chief of the Air Force indicated to them that there was a request by the Minister’s Committee to have a look at the opportunity of looking at a non-costed option so that the performance of the different classes of aircraft could be evaluated fairly.  They also futher requested that the issue of risk be formally included in the value system as a form of scoring element, because although risk had been made visible in each of the stages, in writing it had never been taken into context in the value system point scoring system, and because of the major risk of being the first client of a new aircraft, all of accepting an aircraft that is at the end of its life, the Air Force Command Council within its mandate to protect the South African Public from spending large amounts of money on an aircraft that can never fly or perform within what was contracted.  They then requested that the risk element also formally be included as part of the amended value system before it went to any of the mixed evaluation processes. – [Mr B Kannemeyer]  The Project Team that was sealed with the issuing of the tenders, they were quite happy to proceed even though there was such a vast cost variance.  Is that correct?  It was only after, as was indicated, a higher body indicated that it would not be a good thing to do it in a costed base.  What I mean to be understood by that is that in the opinion of the Project Team, they could actually do an evaluation based on a costed system.  If they were not informed by another body, they would have proceeded on that basis. – [Mr S Shaikh] The costed option and non-costed option in so far as we are taking the military performance dividing by the cost is merely an arithmetic exercise by removing the cost. - [Mr Kannemeyer]  If we can get the opinion of the project team whether they were prepared to proceed on the costed basis and whether, in their opinion, the results emanating from that would have been sufficient to give guidance, if they have not decided to do otherwise. If they say, yes they were, to me it indicates there is a difference in understanding between the different component groups that were working on it.  Because it has indicated the reason why the change came midst then, because the one group that was working on it, proceeded with it.  That is the part that I would like to get to understand. – [Brigadier General OA Schur]  I can respond in this sense that the Project Team was mandated according to the approved value system that had been agreed to before the launch of the process, to have a look at the technical performance of the aircraft, because the aircraft was to be a Lead Infighter Trainer.  The minimum performance standards were cited in the requirement statement.  No allowance was made in the value system that had been drafted at the time to in fact reward an aircraft that could perform beyond that which was required.  That is the first phase.  In the cost exercise therefore, they look purely at the aircraft performance against the measured value system and then provided that aircraft pass by the offered pass to get a military value for money.  It made no difference to the technical evaluation whether they included cost or not because they were looking purely at the functional elements of the aircraft versus the minimum requirements against which they had to measure it. – [Chairperson]  Your explanation of not making cost a limiting factor, that seems to suggest to us that value for money was not a consideration.  Is that true?  Secondly, on the diagram you sent us, which gave us the acquisition cost versus the military value, that suggests to us that for 17% greater value you chose to spend 72% greater cost.  Then finally, information received by the Committee suggested that the normal going price in the industry of this particular model is about 15 million dollars per unit.  We are paying double at 32 million dollars.  Would you comment on those 3 points please? – [Brigadier General OA Schur]  I would like to answer the last one first.  The issue of what an aircraft costs is a very difficult question to ask.  If you look at the first rough order figure of magnitude that the Hawk would have cost us, we also received 15 million US dollars as the first order price.  However, that is for an absolutely unsupported green aircraft with limited functionality.  As we had a look at the aircraft, and the aircraft is defined in terms of the fly away components of the mission equipment that has to be on board and the minimum logistic support, added to that the infrastructure cost to prepare the South African environment to receive this aircraft, the cost increases to what you have visible today.  So unless we know which cost basis we are comparing, it is very dangerous to quote those figures out of context because they may not be referring to the same aircraft or the support level which we have contracted.  If we can then go to the first question just to remind me. – [Chairperson]  The first was whether value for money as a very key component of your considerations of which model to buy.  Secondly, I gave you the figures which came out of your diagram of 72% more cost for 17% more value. – [Brigadier General OA Schur]  I believe that the figures you received may not be quite to scale. However, the amount of cost that you have for the added military value, 17% additional military value in that grading needs almost, in terms of functional performance, a virtual doubling of the aircraft’s capability.  In the case of the MP339, it was a basic trainer with very limited operational capabilities.  The Air Force made a statement also in the Minister’s Council to say that if you look at the minimum requirements of a training aircraft, both aircrafts would suffice.  If the added value of a potential operational utilization had to be considered on top of that, then obviously, the higher cost category of aircraft globally would have satisfied the requirement far better. – [Chairperson]  Then finally on the value for money consideration. – [Brigadier General OA Schur]  I believe that the value for money that has been going today is not only in terms of the military performance of the aircraft that has been selected, but in terms of the national benefit in terms of the counter trade and the industrial participation that has been on offer through this contract,  which in far surpasses anything which the lower cost aircraft would have brought to this country.      – [Mr S Leeuw]  I think the last one has been partly covered by the response.  Who has the ultimate authority to extend the technical value system if it were to be formally amended?  What is the correct procedure when extending any approved value system?  Was the AAC, (Armament Acquisition Council, aware of the fact that if a costed option was done in midstream, other bidders could have been disadvantaged and that the option deviated from such criteria. – [Brigadier General OA Schur]  The value system has to be approved by three parties, but the main role player in the value system determination is the Arms of Service who is the ultimate user of the aircraft or ship that has to be selected.  In the new acquisition process, when a value system is accepted, it is first of all ratified by the Air Force Board.  Secondly, it is then taken to the Project Control Board where both ARMSCOR and the Acquisition Division join in to ratify that in terms of the acquisition process. The changes are acceptable and it is then signed by all the, the CEO of ARMSCOR, the Chief of Acquisitions and then the Chief of the Air Force, to ensure that the changes that have been requested, reflect the best interest of the State.  I think that completes the first question. - [Mr S Leeuw]  Sorry, the first question is not complete.  Who has the ultimate authority?  – [Brigadier General OA Schur]  The ultimate authority to change the value system the acquisition process as it stands is the Project Control Board who has to be convinced that the State would receive benefit by any changes. – [Mr S Shaikh] The Air Force Project Control Board was chaired by the Chief of the Air Force with the Air Force Command Council present.  They are the Statees of the requirement.  They are ultimately the Arm of Service that inherits the equipment and will have to use it for the next 20/30/40 years.  The Chief of the Air Force is the key decision maker with regard to that value system.  He chaired that meeting on that particular day together with the Air Force Board. – [Brigadier General OA Schur]  Then to answer the second question in terms of the costed option versus any changes.  The actual presentation on the request of the Minister to consider a non-costed option was tabled at every one of the Approval Forums where the implications of having a costed option or a non-costed option analysis was tabled and discussed in detail both at the SOFCOM, the AASC, the AAC, at the Council on Defence and at the Minister’s Forum.  Each of these was in fact briefed explicitly on the implications of the use of a costed model or a non-costed model and in the end it was the Minister’s Committee which recommended to Cabinet that the non-costed option should be used to select the preferred bidder based on the advantages at a National Strategic Level that the RSA would benefit from.  – [Mr S Shaikh]  The issue of the cost variants between the two and the economic impact on the two was spelt out to the Minister’s Forum and there is documentation to that effect available in the Department.  So at no point in time did the Department not release that information to the Minister to make an informed discussion and make an informed opinion. – [Mr S Leeuw]  I think on the last answer, are you saying that the presentation at the Minister’s Committee on the 18^th August, two options were represented, the non-costed and the costed? – [Brig Gen O A Shur] I can confirm emphatically that at each of the various and after the Air Force Command Councils are requested to prepare a costed and a non-costed option, the SOFCOM, AASP, the AAC, the COD, the Minister’s Forum and Cabinet were briefed explicitly on Option A being the costed version and Option B being the non-costed version. – [Mr S Shaikh]  My answer to that question is yes. The Director-Generals from the respective departments, from ARMSCOR, Department of Defence, DTI, Department of Finance were in that meeting together with the respective Ministers and the entire issue of the cost and the cost variants with the economic impact was presented and discussed.  The answer to that question then is an explicit yes. – [Mr S Leeuw]  Sir, before I leave that parts of the questioning, I will take the structure of the AAC.  Who might influence the AAC to change the evaluation criteria? – [Mr S Shaikh] The evaluation criteria on the cost and non-costed happened at the Air Force Command Council level where that came in.  It was at the IRI stage before we even tender that the Armaments Acquisition Council discussed the shortlisting process and discussed the issue of the dual performance of two different aircrafts.  You have one aircraft with fundamentally only a training requirement and the other aircraft being two things.  Bear in mind that the limited number of aircrafts we have forced the Department to use a training aircraft, as well as in combat. Those issues were discussed in the Armaments Acquisition Council to start the nature of the type of aircraft that is required downstream. So rather than saying it is an individual, the Air Force Command Council works on a consensus basis. – [Mr S Leeuw] Who represents the Command Council in the Armament Council?  – [Mr S Shaikh] The members for the Armaments Acquisition Council is the Minister of Defence, the Deputy-Minister of Defence, the Chief of SANDF, the Chairman of ARMSCOR and the Secretary of Defence and invited to that meeting was the Chief of the Air Force. – [Mr S Leeuw] The last question is on the risk adjustment. Why was the LIFT project team leader requested to make a risk adjustment to the technical score of the LIFT programme seen in the light that the LIFT system did not include a risk adjustment factor? – [Mr S Shaikh] The Air Force has had a history of assuming risk and doing development aircrafts and ultimately the final cost of an aircraft is largely determined by the demand of risk you assume. In the LIFT aircraft, there are only two aircrafts which are operationally used around the world. The MB339 and the Hawk. The other aircrafts were development type of aircraft. Hence there was no clear defined cost associated to the life cycle costing. The Air Force, in order to assume a ceiling price type of contract did not want to assume risk. That issue was discussed from three Chief’s of Air Force before the present one on  the issue of any new aircrafts assumed by the Air Force should not have a risk element, largely due to the fact that the life cycle costing is the most expensive part of the acquisition of a programme. It is not the upfront cost. It is the 20 to 40 year programme cost. – [Brig Gen O A Schur] The issue of risk adjustment was raised by the Air Force Command Council when they were presented the very first findings of the RFI stage, where risk had always been part of the evaluation team’s responsibility. They had, however, in this case not included it in the technical score but had documented all the risk areas. When the Air Force Command Council listened to the risk elements and the impact that it would have on the national economy downstream, they said that this had to be formally included to make sure that the impact of this risk can be counted for in the military value. That would be expressed at the end of that process. The issue of being the launched customer of an aircraft that has yet to fly in operations, is one element. The issue of the predicted life cycle costs versus actual costs that will be presented by the two aircrafts that were in service was the second factor and the third factor was that in terms of the life cycle of the aircraft being offered, the MB339 was at the final stage of its modification capacity. It had already been modified four times previously, so is the design. The Hawk was in a far younger design life and therefore that risk factor of being the last customer of an aircraft that stands to be phased out is also a risk, because you will have to keep the industry alive for 20 years on your own, because all other clients would have stopped flying that aircraft. For that reason the Air Force Command Council believed that the issue of risk had to be made visible formally. – [Mr S Leeuw] Can I just raise a point of concern at this stage. I am sure the DoD has learned that by putting certain criteria on the ground and changing it, it causes us difficulties. We hope in future that you will be able to come up with clear criteria and policies that would not put this Committee in the predicament. – [Chairperson] Can you give me a number of reference to Strategic Officer Committee (SAFCOM)? Can you explain that Committee, SOFCOM, in relation to the International Office Negotiating Team, IONT, and those two in relation to the negotiating and affordability teams which appear on your organogram? – [Mr S Shaikh] SAFCOM was set up to be a co-ordinating team, because results were being scored with DTI, results were being scored at the Department of Finance, results were being scored by the Air Force on three different programmes and scored by the Navy in two different programmes. Somebody had to co-ordinate all the results to ensure that the results that come out, the point scoring system that comes out of the 300 was clinically done. And members were appointed to the SAFCOM from the respective departments and by ARMSCOR, Air Force and the Navy etc, that ensured that the process will be clinical. The Committee is a co-ordinating Committee. It then tells you what were the results added up accumulatively and it presents them to the Acquisition Forums. The Acquisition Forums it presented to was the Armaments Acquisition Steering Board, chaired by the Secretary of Defence and the Deputy Director-Generals, that is the Chief of the Air Force and the Navy and the Armaments Acquisition Council is the Minister’s one that it goes through. The negotiating team was as, after Cabinet made a decision on 18 November 1998, to make a decision on the preferred bidders and then request a negotiating process to determine the exact price of the contract to see how much the tender price can be negotiated down, what are the terms of the financing, what are the terms of the NIPs and DIPs. That negotiating team was directed largely by the Minister’s Committee. It did not then go to this Acquisition Forums. It went from the negotiating team directly to the Minister’s Committee and direction and guidance was given from the Minister’s Committee. So this negotiating team had the Chief negotiator who was considered to be independent in so far as he did not belong to any department or state. He was brought in from outside as a consultant. Hence, influence from each of the Ministers in the departmental perspective could not be applied to an independent negotiator. That was with regard to the negotiating team. The affordability team is a sub-section of that negotiating team. Again, largely due to the fact that three to four scenarious were presented to the Cabinet Committee Members with regard to what is the ultimate cost. If the figures that were eventually accepted by the Cabinet Sub-Committee was a R21.3 billion contracts, that is committed and it increased it to R29 billion is the Minister of Finance and the Minister of Defence feel that it should conclude the contract of the 19 Griffon Aircrafts. So there is a two tranche approach in that. There is an upfront commitment of R21.3 billion and a second trans of the other 19 single fighter Griffon Aircrafts to bring us to R29 billion. So the affordability team actually determined in this package concept which are the element what it want. Now that affordability team was working mainly with the Stellenbosch University to do an economic impact analysis and what would the current market view South Africa’s purchase. What would the negative effect be on the interest rate? That affordability team was largely to mirror image the macro economic planning of the Department of Finance and they used the Gen economic modeling. So it was a modeling exercise to inform Ministers as to where should they pitch the package value at. – [Chairperson] I just want to get an idea of where the engine room of information management was in these overall structures. Obviously there was a major gathering exercise of information, assessments of it, initial formulation of recommendations and how that went through the structures. I have a fair idea of the roles played by those four Committees that I asked about. – [Mr B Bell] We have heard very early on in this enquiry about the possible industrial developments that are largely to come forward. Can anyone tell us at this stage whether any industrial developments have come forward? – [Mr H S Thomo] Based on these packages that we have just signed last year, there have been some industrial participation happening. – [Mr J van Dyck] What we have today since the effectiveness of the contracts which were in April 2000, I can only talk on the side of the Defence Industrial Participation, they have already drafted credits for contracts placed by BAE on the Griffon project to the value of R118 million, on the Hawk R92.5 million, on Agusta R1.6 million, on Thompson nothing has transpired yet, on the DFC side for the platform part we granted R36.5 million in credits, on the submarine side, that contract only took effect in the beginning of July 2000 and we have not seen any movement there yet. In total we have granted credits to the value of R248.9 million for business already conducted in the short span of time between April and October 2000. – [Mr H S Thomo] Of that R104 billion we have got now R249 million of orders being placed by the suppliers. – [Mr R F Haywood] If you look at it at this moment in time, the joint venture that is taking place already is ensuring that they are not only, as you have seen, breaking even, but they are going to come up with a major supply internationally. So that is a major positive. When you asked about commitment of these overseas companies, I think you should know that the government of Britain has a man who sits at the Department to try and make sure that their offsets work. Secondly, you have another man who sits from the Defence Exports Service organization at the Embassy to ensure their industry will meet their commitments. I am positive, as an industrialist, that we are going to achieve, despite the people who have uncertainty. Therefore the industry at this moment of time, a short period as you have heard, has already seen significant benefits. I believe this will continue very strongly. – [Mr S Shaikh] We need to look at the offset programme in the seven-year time domain. The offset programme is a large part of the responsibility of DTI, but it has a seven-year time span and the payment to suppliers have only been initiated in April and it is the first payment. In some case as in the case of the submarine, no payment has taken place at all to the manufacturer. Merely a payment to safeguard the ECG premiums has been made. Yes, as the months go by, both the Department of Defence and Trade and Industry will be keeping a detailed record of the implementation of the offsets both in rand value as well as in terms of projects and the natures of the projects. – [Mr A Feinstein] Could we get those figures in writing? – [Mr N Gogotya] I was going to request the percentages in terms of the benefits from these contracts. We speak about R1,6 million or R16 million, but  is against what order, because if you are speaking about R13 million against an order of R2 billion, that is just chicken feed in terms of the benefits that you accrued from the size of order. If you could supply us with the percentages to see what benefit do we actually achieve from that particular investment, it would be beneficial. – [Mr S Fakie] I would just like to put the record straight in terms of the statement where it was said there was not enough time given for the Department to respond to our Report and the fact that the three meetings were initially set up and only two meetings took place. That is true. I think the impression that got created is that the third meeting did not take place. That is not correct. The second meeting did not take place. The purpose of the second meeting was merely to give a progress report on where we were with the audit. The third meeting where the finding of the Report and the response from the Department had to be cleared, did take place and that took place on 19 August 2000. Our management letter was issued on 4 July 2000. We got response to our management letter on 14 and 20 July 2000. We have got two lots of responses. The comments from the Department were incorporated into our final management letter on 28 August and the Report was then finalized. So in terms of whether there was adequate time given to respond, I really believe that if one looks at those timeframes, there was adequate time given to respond. The meeting took almost a month and a half after the management letter was issued and the third meeting did take place. What this Committee knows is that in finalizing the Report, there was a bit of an urgency because today is the last meeting that this Committee will be having and that I did get permission from the Minister to dispense with the seven days, but the seven-day issue relates to merely the Minister being aware of the content of the Report and the seven-day period is not to discuss the findings of the Report and that did take place.

Mr N du Plessis] I can also make available the finance agreements signed by the Minister of Finance to the Committee. Just to confirm, there was at some stage confusion about whether the bulletin should be included in the MTEF, that is the case, if you are dealing within the MTEF with a total budget for the whole package.

Chairperson] To conclude the meeting we have asked Mr A Feinstein to conclude it with a few observations and general issues of substance that have come up thereafter I will just remind us of the process in the way forward.

Mr A Feinstein] I am sure that all members on all sides of the House will agree that this is probably the most difficult issue and certainly the most complex, the most material and possible the most important to come before the Committee. I am also sure, and I could speak for all the members, when I say that we need to take very seriously the task that is before us. The issue has been characterized by an enormous amount of rumour and conjecture. I think it is critically important that we as elected representatives know everything there is to know about this deal. That we consider this information in a non-partial, non-party political and fair manner, so that we can once and for all either deal with any irregularities, regardless of what those irregularities might be or who is involved in them, or clear the air once and for all, including any names that have been mentioned in the conjecture. As a Committee I would like to suggest that our integrity in dealing with this issue must be unequivocal. Public Accounts is about public accountability and public accountability is about strengthening and deepening our nation’s democracy in the institutions of this democracy. In the course of our work this Committee will hopefully be able to make a small contribution to the realization of that objective. Clearly there are areas that remain murky or confused on which we need more information. There are some issues that are very real concerns, particularly the lack of any formal conflict of interest declaration which is a massive problem to us, the issues of interaction with and between sub-contractors and between sub-contractors and contractors that was not covered by this Report, the extent and likely impact of economic benefits to the country of the deal, and a number of elements of the actual procurement process, especially still issues around the corvette and LIFT aspects. The Committee needs to determine how best we pursue these issues. If I could just state that it should, as in all of our work, be with the understanding that we at all times work in the interests of the people of South Africa whose money we are after all talking about today.

Chairperson] In conclusion from myself, I need to thank all officials for attending today and thank you for your co-operation. We will embark on an assessment of this evidence now. I am proposing to the Committee that the group that did the preparation work for this particular Hearing, that they be mandated by the Committee to continue with that assistant work during the course of the next two weeks, which would involve, not only assessing the evidence we have thus far, the assessing of the high volume of documentation we have requested from both Departments before us today. And for us to try and be in a position to have formulated at least a draft assessment and resolutions and recommendations for our meeting on Monday, the 30^th of October. Do we have that mandate? Thank you. We will present our report to you and get your input before formalizing it and submitting it to Parliament. As Andrew has indicated correctly, there might well be the decision to pursue some sort of investigation which could be along the lines of a forensic nature. I think we might consider the need, if we pursue that course, to extend that investigation to also cover a business economic aspect more on the cost benefit side, which would not be strictly forensic, but it will be that type of investigation which we will see if we can narrow down those figures that seem to often during the course of our deliberations in the earlier part of the day. With the Committee’s permission, could we proceed on that basis and could we remind the Departments of their commitments to send us the documentation we have requested. We have also noted which documentations we have requested. If you are unsure on any of those documents, please get in touch with our Committee Section. And that our understanding is that all that documentation is in existence. It is simply a matter of getting it to us. I do not think it will be unreasonable to ask you that we have it by this coming Monday. Thank you Auditor-General for being here.