Tough New Ethics Rule for Govt. Contractors

The new federal contracting rule that requires all companies doing business with the federal government to have an effective ethics and compliance program in place hasn’t even started yet, and already there is clamoring to change it.

Federal Acquisition Rule Subpart 3.10, which will come into effect on Dec. 24, compels companies with government contracts and sub-contracts worth more than $5 million and lasting longer than 120 days to establish a written code of ethics and business conduct within 30 days of winning a contract. The rule also states that contractors must establish an employee ethics and compliance training program and an internal control system “proportionate to the size of the company” within 90 days after a contract is awarded.

Now the Department of Justice says that’s not good enough, and wants to apply the rule to all government contractors—regardless of the contract’s size or duration. In addition, the Justice Department’s proposal would mandate that government contractors notify the agency’s Office of Inspector General and the contracting officer any time the company has a “reasonable” basis to believe a violation of federal criminal law has been committed in connection with its government contract.

Finally, the DoJ’s proposed amendment states that if a contractor or sub-contractor knowingly fails to disclose such violations, it would be at risk for suspension and debarment.

Pages

“That’s the big deal here,” says Krista Pages, a government-contracting lawyer with the firm Winston & Strawn.

The DOJ amendments are contained in a proposed rule titled, “FAR Case 2007-006 Contractor Compliance Program and Integrity Reporting.” This proposed rule was published in the Federal Register on Nov. 14 for public comment through Jan. 14. After that, the Civilian Agency Acquisition Council and the Defense Acquisition Regulations Council

will review the comments and publish final amendments.

Considering that the first FAR amendment took almost nine months to come out from when it was first proposed, it may be well into 2008 before the latest rule to come out, Pages says. Nevertheless, it is a sobering proposition for many companies.

The Justice Department’s proposal originated partly out of concern that only about 1 percent of contractors voluntarily report a violation once they become aware of it, Pages says.

Bednar

Participation in a voluntary disclosure program launched by the Department of Defense more than two decades ago also has dropped off dramatically in recent years. This year, according to Richard Bednar, of the law firm Crowell & Moring, only a handful of volunteers stepped up to report probable wrongdoing.

The hesitation to report may reflect employees’ fear of retaliation if they say anything. A recent study by the Ethics Resource Center found that more than 40 percent of employees choose not to report ethical misconduct through company channels; many fear retaliation or believe that their action would have no effect. The survey also found that about 12 percent of those who reported misconduct did indeed experience retaliation.

ETHICS PROPOSAL

Below is a portion of the Justice Department proposal to amend FAR Subpart 3.10.

Within 30 days after a contract award, unless the contracting officer establishes a longer time period, the Contractor shall: (i) Have a written code of business ethics and conduct; and (ii) Provide a copy of the code to each employee engaged in performance of the contract.

The Contractor shall: (i) Exercise due diligence to prevent and detect criminal conduct; and (ii) Otherwise promote an organizational culture that encourages ethical conduct and a commitment to compliance with the law.

The Contractor shall notify, in writing, the agency Office of the Inspector General, with a copy to the Contracting Officer, whenever the Contractor has reasonable grounds to believe that a principal, employee, agent, or sub-contractor of the Contractor has committed a violation of Federal criminal law in connection with the award or performance of this contract or any sub-contract thereunder.

Business ethics awareness and compliance program and internal control system for other than small businesses. This paragraph does not apply if the Contractor has represented itself as a small business concern pursuant to the award of this contract. The Contractor shall establish the following within 90 days after contract award, unless the contracting officer establishes a longer time period:

An ongoing business ethics and conduct awareness and compliance program. This program shall include reasonable steps to communicate periodically and in a practical manner the Contractor’s standards and procedures and other aspects of the Contractor’s business ethics awareness and compliance program and internal control system, by conducting effective training programs and otherwise disseminating information appropriate to an individual’s respective roles and responsibilities.The training conducted under this program shall be provided to the Contractor’s principals and employees, and as appropriate, the Contractor’s agents and subcontractors.

An internal control system.

Source

Federal Register (Nov. 14, 2007).

With only a limited number of investigators to police the federal government’s vast contracting business, the Justice Department wanted a mechanism to prod more individuals to step forward, experts say.

“They’re saying, ‘We’re going to put the burden on you. If you know there’s been a violation of any statute, we expect you to tell us about it and take corrective action,’” Pages says.

The Justice Department may also be inspired by its experience working with other enforcement agencies (principally the Securities and Exchange Commission) on compliance and corporate governance issues that have exploded since passage of the Sarbanes-Oxley Act. Confronted with fraud allegations about the Iraqi occupation, Hurricane Katrina cleanup, and more, Pages says, the department wants to implement the same sort of guidelines on government contractors that it helped impose on public companies.

If this proposed amendment is promulgated, “that will have a very profound effect on the U.S. business community overall,” says Worth MacMurray, head of Compliance Initiatives, a consulting firm for contractors. “It would be another strong signal that corporate compliance programs are highly advisable. The influence directed toward the government contracts community will spill over.”

MacMurray also believes the Justice Department changes, if enacted, would lead to other incentives that might spur companies outside the government-contracting world to comply with them anyway. For example, he says, companies that meet the more stringent compliance standards might receive better director and officer liability insurance rates. Higher ethical standards might also improve employee retention, he adds.

Prepare Yourself

For large government contractors—the Halliburtons, Raytheons, and Boeings of the world—the new FAR Subpart 3.10 is trivial; they have long had to deal with much more complicated compliance regimes. Small companies, or those new to the contracting game, may have their work cut out for them. Pages suggests that those companies review their system of internal controls to help prepare for the changes to FAR compliance regulations.

In particular, she recommends that companies take a hard look at how they conduct audits and make sure that the auditors performing the work are familiar with the federal market.

“An auditor might be familiar with accounting and Sarbanes-Oxley issues, but may not necessarily be trained in government contracts and auditing, which has some different rules,” Pages explains. “You have to make sure procedures are being tailored to your government contract. If you don’t, you’re facing heavy fines and potential disbarment.”

For example, in addition to the usual accounting regulations, government contractors need to comply with federal labor laws and socio-economic programs imposed under FAR, she says.

Before the Justice Department’s proposed amendment is adopted, Bednar would like the government agencies involved to consider some steps to revitalize a voluntary disclosure program. In the case of the Department of Defense’s program, for example, the agency could promote the virtues of voluntary disclosure more rigorously, and explain the agency’s expectations more clearly, he says.

Those expectations are a double-edge sword, however. On the positive side, if a company makes the voluntary disclosure, the expectation is that the company itself wouldn’t be criminally prosecuted. In making that disclosure, however, the company would almost automatically need to pay a penalty of double the damages to the government, as outlined under the False Claims Act.

Admittedly, “that’s a disincentive,” Bednar says. But if the expectations “were clearly stated or made known, they’d get more cooperation,” he contends. “The program was well-conceived and worked in the beginning. It can be made to work again.”