A Sea Change In Government Contracts Comes With Policy Alterations

August 14, 2009

By: Marc Stephen Raspanti , Douglas K. Rosenblum

Given the current economic downturn and the transfer of power that occurred in Washington on Jan. 20, it is crucial for contractors and taxpayers alike to analyze certain regulations that became effective in the waning days of the Bush administration and review how they may be applied by the Obama administration. The Contractor Code of Business Ethics and Conduct, a comprehensive and onerous regulation of the Department of Defense, the General Services Administration and the National Aeronautics and Space Administration, became law on Dec. 12, 2008, and is codified at 48 C.F.R. § 52.203-13 (2008). This amendment to the Federal Acquisition Regulation requires government contractors to create corporate infrastructure to detect unethical behavior and, more importantly, the mandatory disclosure of any such behavior detected by the company to the federal government. This presents a significant sea change for the contracting industry.

The New Ground Rules

Under this new code, government contractors that are awarded projects with a value in excess of $5 million and an anticipated duration in excess of 120 days shall institute a written code of business ethics and conduct. This written code must be in place within 30 days of the award of the contract. Within 90 days of award of the contract, the contractor must institute an ongoing business ethics awareness and compliance program, including training for principals and employees of the business and a full internal control system. Perhaps the most daunting requirement placed on government contractors under this new provision, and the most drastic departure from past practices, is the following mandatory disclosure requirement: “The Contractor shall timely disclose, in writing, to the agency Office of the Inspector General … whenever, in connection with the award, performance, or closeout of [the] contract or any subcontract thereunder, the Contractor has credible evidence that a principal, employee, agent, or subcontractor of the Contractor has committed … a violation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity … or … a violation of the civil False Claims Act.”

Of significance, this disclosure requirement extends until three years have elapsed following the date of the final payment on the contract, but it is not retroactive.

The nature and timing of these disclosures are topics of great interest and were discussed at length in the Nov. 12, 2008, publication of the new code in the Federal Register. Contractors need not disclose past conduct of an employee discovered during a background check, for example, that an applicant was convicted of bribery, but commentary to the new code suggests that such information should be part of the decision whether to hire the employee. Past criminal behavior of any type bears on that person’s integrity and his ability to be an effective role model for company staff. The more difficult decisions arise when corporate compliance programs detect evidence of ongoing fraud.

Higher Stakes

Contractors who rely on federal money for a substantial portion of their income must review these requirements carefully. A violation of the Contractor Code of Business Ethics and Conduct provides for suspension or debarment of a contractor. It may even form the basis for whistleblower lawsuits by insiders who become aware that these provisions are not being followed.

The federal government, along with 24 states and the municipalities of Chicago, New York and the District of Columbia, have False Claims Acts in place that allow for private citizens to blow the whistle on companies submitting false or fraudulent claims for payment to the government. Individuals with knowledge of such unlawful practices have financial incentive to come forward and file these “qui tam” suits. The statute provides for the whistleblower to receive up to 30 percent of any recovery received by the government. The contractor may be exposed to treble damages and sizeable penalties, including the payment of the whistleblower’s attorney fees and costs. Although recent recoveries under the statute have occurred in the pharmaceutical industry, and specifically in off-label marketing cases, defense contracting has been the subject of many past qui tam actions. Under the new code, if a contractor certifies to the government that it has instituted a written code of business ethics and conduct and is in full compliance, but an employee or insider discovers that is not so, the potential exists for any claims for payment made by that contractor to be tainted as false and susceptible to penalties under the False Claims Act.

Evolution of the Code

Of course this new code is not without its vocal critics. This rule was promulgated in response to a request made to the Office of Federal Procurement Policy by the Department of Justice and in response to the Close the Contractor Fraud Loophole Act. In the publication of the final rule in the Federal Register, 28 pages of comments and responses followed the background and summary of the regulation. Respondents to the proposed version of the new code expressed concern over the time and money required of contractors to comply with the new regulation. The Department of Defense, the General Services Administration and NASA made clear that there will be additional costs and efforts required on the part of contractors that do not have these important measures already in place, but these steps are reasonable and justified to mitigate “other and larger risks to the success and efficiency of Government Projects.” Part of the justification provided for such measures is that some contractors have already invested in such precautions, and this rule will “level the playing field in competitive environments.”

In the highly competitive environment of government contracting, mandatory disclosure is a monumental step forward from the past policy of voluntary disclosure (a policy largely ignored by contractors for the past 10 years). Mandatory disclosure has been adopted by the banking industry and public companies, and the practice has been stressed by the U.S. Sentencing Commission and the Department of Justice. Defense contracting is a massive industry for the United States, but its reputation has not always been the most pristine. Anne Flaherty of the Associated Press published an article on March 23 headlined “Def. Sec. Gates: Use of Private Contractors ‘Vital’ in Afghanistan, U.S. Military’s ‘Help Wanted’ Sign,” which addressed this very point. The mere mention of Blackwater, for example, is enough to evoke a negative impression of the industry based upon its errors in Iraq as a defense contractor — which is undoubtedly the reason the company recently changed its name to Xe.

With the United States currently entrenched in military activity in Iraq and Afghanistan, as well as in many other parts of the globe, many government contractors are providing large-scale support to U.S. troops. This new code will affect how our country operates around the globe. As of March 23, there were 71,700 U.S. government contractors in Afghanistan alone; this was more than double the number of U.S. troops in that country at the time. In the wake of Blackwater’s much publicized failures in Iraq, for example a drunken Blackwater employee allegedly killing an Iraqi politician’s bodyguard, the new code appears relevant and needed. Despite these well-known issues, the first proposed version of the new code included an exception for overseas contacts. One agency OIG opined: “[I]t is counterproductive to exclude contracts performed entirely outside the United States because the United States is still party to such contracts and may be victimized when overpayments are made or fraud occurs in connection with those contracts … the contracts require greater vigilance because they are performed overseas where U.S. resources and remedies are more limited … and the inclusion would reduce the vulnerabilities that often plague overseas programs and increase the effectiveness of those programs.”

The agencies agreed, and no such exclusion for contracts performed outside of the United States made its way into the final version of the code.

The New Administration

President Obama issued a memorandum for the Heads of Executive Departments and Agencies on March 4, without explicitly referencing safety and security concerns, but with a clear message of fiscal responsibility. Spending on government contracts has more than doubled since 2001, exceeding $500 million in 2008. The president cites a GAO study conducted in 2008 of 95 “major defense acquisition projects” that found cost overruns of 26 percent, totaling $295 billion over the life of the projects. In an effort to curb wasteful spending, Obama has directed the following: “The Director of the Office of Management and Budget (OMB) … to develop and issue by July 1, 2009, Government-wide guidance to assist agencies in reviewing and creating processes for ongoing review of existing contracts in order to identify contracts that are wasteful, inefficient, or not otherwise likely to meet the agency’s needs, and to formulate appropriate corrective action in a timely manner. Such corrective action may include modifying or canceling such contracts in a manner and to the extent consistent with applicable laws, regulations, and policy.”

The president has instituted a tight timeline for this project and has set a deadline of Sept. 30 for the director of OMB to issue “Government-wide guidance” to govern the use of no-bid contracts versus competitive contracts, the assessment of when such contracts are needed or appropriate and the oversight of these contracts going forward.

With heavy reliance on contractors, especially in the battle zones of Iraq and Afghanistan, the juxtaposition of the new Contractor Code and Obama’s March 4 memorandum sets up a significant sea change in defense and procurement contracting. The new administration is pushing for a leaner workforce and has not indicated any intent to repeal the new code. Therefore, the contractors remaining after the intended thinning of the workforce must spend time and money to create stringent ethical rules and notify the government of any credible evidence of unethical behavior by its own employees.

Will government contracting thrive, or will contractors find the negatives outweigh the positives of receiving paychecks from Uncle Sam? Aaron Smith’s Feb. 10 article published on CNNMoney.com headlined “Military Recruitment Surges as Jobs Disappear” provides interesting data. Given the historic level of job losses in the United States, military recruiting is meeting and, in some cases, exceeding its goals, even though more than 4,800 soldiers have been killed in Iraq and Afghanistan. The U.S. military provides a stable source of income and benefits when the U.S. civilian market lost 2.6 million jobs last year alone. Our country has so heavily relied upon defense contractors abroad, that it appears unlikely recruiting efforts will surmount the nearly 72,000 men and women needed in Afghanistan alone to replace the current workforce.

The Future

Although excessively stringent implementation and high costs could lead to companies dropping out of the race for some contracts, procurement and defense contracting is too lucrative a business for contractors to crumble under the added cost of implementing ethical guidelines. If the new code is enforced and the Obama administration sets its course, contractors should proceed cautiously in a new and changing regulatory environment. Contractors may be wary of the federal government imposing more and more regulations on an industry with fewer and fewer officials to monitor compliance, but these changes are here to stay and counsel must be ready to assist clients in navigating the new terrain.

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