January 07, 2008
Government Contracts Alert
Author(s): Brian K. French
In the final weeks of 2007, the federal government amended the Federal Acquisition Regulation (“FAR”) to impose new compliance obligations on government contractors. Under the new FAR rule, which became effective on December 24, 2007, contractors must adopt written codes of conduct and implement internal compliance control systems. In addition, the government is also considering a further amendment to the FAR, which would subject contractors to mandatory disclosure requirements and compel “full cooperation” with government investigators. The comment period for this proposed rule ends on January 14, 2008.
By Brian K. French and Jacob B. Pankowski
On November 23, 2007, the Civilian Agency Acquisition Council and the Defense Acquisition Regulations Council (the Councils) issued a new FAR rule requiring contractor codes of business ethics and conduct and related compliance programs. The new regulation applies to contracts that are expected to exceed $5 million in value and have performance periods of 120 days or more. It does not apply to commercial item contracts or to contracts performed entirely outside the United States. Nixon Peabody published a prior alert discussing the proposed rule that, in large part, has now become part of the final rule. See “New Proposed Rule Could Impose New Procurement Integrity Requirements,” available at www.nixonpeabody.com/publications_detail3.asp?ID=1713.
Under the new rule, a covered contractor must have a written code of business ethics and conduct within 30 days after the award of a covered contract. Unless the contractor is a small business, it must also, within 90 days after contract award, establish an ongoing business ethics and conduct awareness program and an internal control system that will facilitate the discovery of improper conduct and ensure that corrective measures are promptly instituted.
The new regulation includes flowdown provisions that subject subcontractors to the same compliance obligations as prime contractors. A contractor is not required to monitor the ethics awareness programs and internal control systems of its subcontractors, but must nevertheless “check” for the existence of those programs.
Finally, contractors must display fraud hotline posters if the contract exceeds $5 million and is with an agency that has a hotline poster or is funded with disaster assistance funds. Except for contracts funded with disaster assistance monies, contractors need not display agency hotline posters if they have implemented a business ethics and conduct awareness program that includes a fraud reporting mechanism.
On November 14, 2007, at the request of the U.S. Department of Justice (DOJ), the Councils proposed an additional FAR amendment that could dramatically change the way in which government contractors handle information about possible wrongdoing within their organizations. Like the Final Rule, the proposed regulation would apply to contracts in excess of $5 million and with performance periods of 120 days or more. It would not apply to commercial item contracts or to contracts performed entirely outside the United States.
DOJ’s proposed rule would modify FAR’s new section on contractor codes of business ethics and conduct to mirror those provisions of the U.S. Sentencing Guidelines for Organizations that identify the elements of an “effective” compliance program. More significantly, the proposed rule would require contractors to notify the government in writing “whenever the Contractor has reasonable grounds to believe that a principal, employee, agent, or subcontractor of the Contractor has committed a violation of [f]ederal criminal law in connection with the award or performance of [the] contract or any subcontract thereunder.” Contractors could be suspended or debarred for a “[k]nowing failure to timely disclose” a criminal violation or an overpayment on a government contract. In addition, the proposed rule would obligate contractors to provide “[f]ull cooperation with any [g]overnment agencies responsible for audit, investigation, or corrective actions.”
As discussed below, the combination of mandatory disclosure and full cooperation requirements raises a number of troubling issues.
For decades, voluntary cooperation and self-disclosure have been central to the way in which corporations, government agencies, and federal prosecutors approach possible criminal activity within an organization. Of particular relevance to government contractors, in the wake of reported defense spending waste and contractor fraud in the mid-1980s, President Reagan established the so-called “Packard Commission” to recommend reforms for the defense procurement system. The Packard Commission recommended the establishment of ethics codes within the defense contracting industry and a program to govern voluntary disclosure of contractor misconduct to the Department of Defense (DOD). In 1986, largely in response to the Packard Commission’s recommendations, but also on their own initiative, a number of major defense contractors drafted the “Defense Industry Initiatives on Business Ethics and Conduct” (DII). A key principle of DII is that each signatory company “has the obligation to self-govern by monitoring compliance with federal procurement laws and adopting procedures for voluntary disclosure of violations of federal procurement laws and of corrective actions taken.” That same year, DOD adopted a Voluntary Disclosure Program to encourage internal investigations and early reporting of illegal activity by defense contractors in exchange for the possibility of more lenient treatment.
In 1991, the U.S. Sentencing Commission adopted the Sentencing Guidelines for Organizations (the Guidelines), which incorporated the concept of voluntary corporate self-policing. According to members of the Sentencing Commission, the main goal of the Guidelines is not punishment, but rather, “the promotion of good corporate citizenship through encouraging implementation of effective compliance programs, which – it is hoped – will prevent crime.” Under the Guidelines, a corporation may receive a reduction in its “culpability score” if, “prior to an imminent threat of disclosure or government investigation … and … within a reasonably prompt time after becoming aware of the offense, [the corporation] reported the offense to appropriate governmental authorities.” The Guidelines are based on a “carrot and stick” approach to corporate crime, in which companies that fail to take certain actions, such as establishing strong compliance programs, voluntarily disclosing misconduct, and fully cooperating in government investigations, face harsh penalties, while companies that voluntarily take such measures may avoid onerous sanctions.
Voluntary cooperation and self-disclosure also have become important variables in the charging decisions made by federal prosecutors. In 1999, then-Deputy Attorney General Eric H. Holder issued a policy memorandum entitled “Federal Prosecution of Corporations” (the Holder Memorandum), which was intended to guide prosecutors in deciding whether to charge a corporation with a crime. The Holder Memorandum provided that, in making their charging decisions, prosecutors should consider “[t]he corporation’s timely and voluntary disclosure of wrongdoing and its willingness to cooperate in the investigation of its agents.” In December 2006, then-Deputy Attorney General Paul J. McNulty issued a memorandum (the McNulty Memorandum) that revised the charging guidelines to require prosecutors to consider a company’s voluntary cooperation and disclosure in deciding whether to charge an organization.
In support of its proposed rule, DOJ has claimed that mandatory disclosure is necessary because few companies have responded to DOD’s invitation to voluntarily report suspected criminal activity. This seems to imply that criminal behavior among contractors is going unreported and unaddressed and that other explanations for the reportedly low levels of participation in the Voluntary Disclosure Program do not exist.
In 1996, the U.S. Government Accountability Office (GAO) observed that, while many of the top defense contractors had made voluntary disclosures since the inception of the program, the total number of disclosures was still relatively small. Although GAO failed to opine on why more companies had not taken advantage of the program, it noted that voluntary disclosures to DOD took an average of 2.8 years to complete, with roughly 25 percent taking more than four years, and that case management was a low priority for the investigative agencies. More recently, DII acknowledged that the number of reports to DOD under the Voluntary Disclosure Program has diminished over the past few years. However, according to DII, this decrease is explained by “[l]ess emphasis by [DOD]; fewer reportable instances; more issues being resolved under the contract as contract issues, rather than as ‘criminal’ issues; industry perception that the government is slow in processing disclosures; [and] concern that there is no restriction on the use of a disclosure report in criminal, civil or administrative actions against individuals.” It is believed that most instances of misconduct in connection with government contracts are resolved informally through reports to contracting officers and contract administrators.
In any event, regardless of DOJ’s justification for its proposed rule, there are a number of reasons why mandatory disclosure and full cooperation requirements would be detrimental to both contractors and the government:
Nixon Peabody is preparing formal comments on the proposed rule, which must be submitted to the FAR Secretariat on or before January 14, 2008. Interested parties should contact the attorneys listed above with any questions or input they would like to provide.
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