WASHINGTON (Reuters) - The Pentagon’s top watchdog has abandoned efforts to do in-depth audits of defense contracts, leaving billions of dollars in taxpayer money at risk because of overpayments and fraud, according to an investigative report due to be made public on Thursday.

An aerial view of the Pentagon in Washington August 31, 2010. REUTERS/Jason Reed

The report, written by Republican Senator Chuck Grassley’s staff and obtained by Reuters, concludes that the Defense Department’s Office of Inspector General has focused instead on less important types of audits, and that its productivity has plunged in recent years.

It said the inspector general’s office in fiscal 2009, which ended September 30, 2009, did not audit any “major or non-major weapons contract or contractor.”

The report contends too that the inspector general’s office has failed to follow up even when it finds evidence of serious misdeeds.

In one example, auditors in 2007 stumbled upon a recurring error in the Pentagon’s overall financial statements, because military officials had failed to record $1 billion in proceeds from the sale of closed U.S. military bases in Europe.

They also found that about $107 million of the money had disappeared. However, senior officials turned down the auditors’ recommendation to launch an investigation.

The watchdog’s poor performance, the report says, has resulted in little oversight in recent years of annual payments to contractors, which currently total more than $390 billion, up from $154 billion in 2001.

The report said that misdirected efforts by the watchdog left “huge sums of the taxpayers’ money vulnerable to fraud and outright theft.”

It said this lack of thorough audits occurred despite a 35 percent increase in the inspector general’s staff since 2003, to 765 employees.

The Grassley report, however, also puts heavy blame on the Defense Department itself for inadequate oversight of contracts.

BROKEN SYSTEM

It says that the Pentagon’s accounting systems are in disarray and that vast quantities of payment records are missing, leaving little trail for auditors to follow.

The report comes shortly after Defense Secretary Robert Gates and the White House announced plans to cut waste from defense spending, mainly by cutting back on unnecessary projects and reducing personnel costs. But the Grassley report says great savings could be achieved by rigorously auditing defense contracts.

“Discovering that the (inspector general) no longer does genuine contract audits was a startling revelation but one that helps to explain why 765 OIG <Office of the Inspector General> auditors could not document any measurable fraud in FY 2009,” Grassley said in a letter to Gates about the forthcoming report.

The letter urges Gates to focus more on the Defense Department’s “broken accounting system” and improving oversight by the inspector general.

Gary Comerford, a spokesman for the inspector general’s office, said it hadn’t yet received a copy of the Grassley report. “We haven’t seen it. We haven’t read it and there’s really nothing we can say until we’ve had an opportunity to take a look at” it, he said.

While the report faults the inspector general for not doing comprehensive audits of major contracts, public records show instances in which the inspector general’s office has recouped hundreds of millions of dollars after investigating single provisions in contracts.

For example, a 2008 audit led to recovery of more than $500 million after auditors found that the military had overpaid Boeing on contributions to employee pensions required under contracts for aircraft.

ANONYMOUS TIPS

The report said Grassley’s inquiry began after disgruntled employees in the inspector general’s office in January 2009 slipped anonymous notes under his office door and followed up with information in anonymous faxes.

The notes complained of alleged mismanagement, declining numbers of audits, and failure to focus on areas most vulnerable to fraud, particularly defense contracting.

Grassley, ranking Republican on the Senate Finance Committee, has a long-standing interest in waste in military spending.

Inspectors general have the primary responsibility at federal agencies for preventing and detecting fraud and abuse.

The report said that despite the big increase in the inspector general’s staff, productivity had fallen. The office issued only 113 reports on all subjects in 2009, which the Grassley report said was the lowest productivity rate by staff members in at least 20 years.

The report said the need for contract audits has been heightened by the Pentagon’s adoption of two automated systems that speed up payments to contractors and issue checks before contractors submit invoices documenting amounts owed.

The report said the systems are “highly vulnerable to fraud” because there is scant effort by contracting officials to see if the payments were justified once the Pentagon receives the invoices.

In an example of how the Defense Department’s lack of basic accounting records thwarts investigations, the report cited an attempt in 2009 to audit a $621 million contract to Falls Church, Virginia-based DynCorp International to oversee storage of military supplies in Southwest Asia.

Auditors found signs of possible unjustified payments to DynCorp. But they were stymied when they found that invoices and other essential records were missing. Ultimately they had to ask the company itself for copies.

Even so, “the audit team was still unable to connect the dots and determine whether the taxpayers were cheated out of $161.1 million,” the report said.

The report said the inspector general should shift a big portion of his staff to better use by sharply curtailing futile efforts to audit Defense Department financial statements until the Pentagon puts in place a more functional, modern accounting system.

Defense department officials have said that may take until 2020.