Proposed Rule Focuses on Audit of  Business Systems, May Expedite and  Streamline Process 

On July 15, the Department of Defense (“DOD”) released a  proposed rule, 79 Fed. Reg. 41172, that will allow contractors that  are subject to the requirement for audit of key business systems  (more than $50 million annually of contracts requiring cost or  pricing data) to self-certify that their key business systems are  adequate and to elect to use DOD-approved third-party auditors to  periodically validate those same systems. The comment period  ends on September 15, 2014.  The Defense Contract Audit Agency (“DCAA”) is tasked with  examining accounting and billing, estimating, material  management, and accounting systems, while the Defense  Contract Management Agency (“DCMA”) reviews purchasing,  government property and management, and earned value  management systems. Collectively, these systems comprise the  key business systems that give rise to the generation of cost or  pricing data that covered contractors are required to deliver in  support of their offers. The proposed rule would leave the DCMA  review process largely unchanged (DCMA is not as inundated with  other audit work as is DCAA).  The proposed rule could be a net positive for contractors (and for  DCAA, whose auditors are years behind in their review of incurred  cost submissions). The proposed rule, if adopted, should ease the  audit load that would otherwise be imposed on DCAA and thereby  expedite the process and time frame for conducting business  systems audits, thus giving contractors greater control over how  and when those reviews are completed.  There is a dark side, however, to the proposed rule:  contractors  who opt to self-certify and rely upon outside audit firms will be  required to provide to those auditors (and therefore, to the  government) their internal audit work papers and related materials  generated in connection with the self-certifications. In contrast,  production of those same papers would not be required of  contractors in a DCAA review. The accompanying requirement  for delivery of records could give rise to creation of new or  different work papers by personnel who operate outside the  accounting and finance functions as a way of walling off those  routine but nonetheless sensitive functions from the business  systems review (operating much like an ombudsman). In other  words, even with additional requirements for record  transparency, contractors and their advisors will likely evolve  the finance and accounting functions to avoid having to produce  pure accounting and finance records, while still complying with  the requirement for delivery of records that substantiate the  adequacy of business systems. D.C. Circuit Extends Attorney-Client  Privilege to Internal Compliance  Investigations  In recent years, numerous trial courts have ruled that  communications between counsel and corporate executives or  other personnel are protected by privilege only if the “primary  purpose” of the exchange was to request or furnish legal  advice, thereby potentially exposing to discovery  communications in connection with the investigation of  regulatory and compliance matters. See, e.g., United States v.  ISS Marine Servs., Inc., 905 F. Supp. 2d 121, 128 (D.D.C.  2012) (but for the request for legal advice, the exchange with  counsel could not qualify for privilege). Recognizing that  companies often undertake actions for multiple overlapping  reasons, the D.C. Circuit rejected the “but for” test,  concluding  that the attorney-client privilege applies  “[s]o long as obtaining  or providing legal advice was one of the significant purposes of  the internal investigation.”  In re Kellogg Brown & Root, Inc., –  F.3d –, 2014 WL 2895939, at *4 (D.C. Cir. 2014). In other  words, the request for legal advice need not be the primary  purpose of the communication.  •  Proposed Rule Focuses on Audit of  Business Systems, May Expedite and  Streamline Process  •  D.C. Circuit Extends Attorney-Client  Privilege to Internal Compliance  Investigations  •  Executive Order 13665 Allows Agencies to  Terminate Contracts If Contractors   Retaliate Against Employees Who   Disclose Compensation  •  Proposed DOD Rule Expands Contractors’  Risk of Personal Conflicts of Interest   •  DOD’s Restrictions on Counterfeit Parts  Rule Is Limited to Electronic Parts, but More  Changes Are Expected   •  DOD’s New FOCI Rules Present New  Challenges to Contractors with Foreign  Connections   •  Would-Be Service Contractors Face  Exposure of up to $10,000 Penalty per Day  under HHS Contracts  •  GAO Decides That Small Business Joint  Venture Proposals Do Not Require SBA PreApproval  •  Baker Team Secures Arbitration Award for  Wrongful Termination of Subcontract  •  Legislative and Regulatory Updates  www.bakerlaw.com The Government Contracts Quarterly Update is published by BakerHostetler’s Government Contracts Practice Group to inform  our clients and friends of the latest developments in federal government contracting.  This Quarterly Update is for informational purposes only and does not constitute specific legal advice or opinions. Such  advice and opinions are provided by us only upon engagement with respect to specific factual situations. This communication is considered attorney advertising. The KBR decision is especially important to government  contractors because the original controversy arose in  connection with a government contract. In KBR, a former  employee advanced numerous allegations of improper  conduct by KBR. KBR conducted an internal investigation,  overseen by in-house attorneys, into many of the alleged  improprieties. The investigation was commenced in  fulfillment of the company’s Code of Business Conduct,  which was, in turn, promulgated to comply with Department  of Defense contracting regulations requiring internal control  systems. See 48 C.F.R. §§ 203.7000–203.7001(a). Before  the lower court, the qui tam relator endeavored to compel  production of investigative materials and files prepared by  counsel and communicated to management. The district  court found that KBR was obligated to conduct an  investigation regardless of its need for legal advice, and  therefore, the subject communications could not qualify for  the privilege. In reversing the lower court, the D.C. Circuit  eliminated what it viewed as a “false dichotomy,” thereby  restoring the safe haven that has always been provided  under the attorney-client privilege. This holding allows  businesses to plan and execute internal investigations  without the risk of exposing to discovery all of their  investigative communications with counsel, thereby  preserving the need for and provision of candor between  client and counsel.   Executive Order 13665 Allows Agencies  to Terminate Contracts If Contractors  Retaliate Against Employees Who  Disclose Compensation  On April 8, President Obama signed Executive Order  13665, aimed at combating employer policies restricting or  prohibiting employees from being able to discuss  compensation with colleagues, thereby curtailing the  practice of preventing employees from discussing  compensation data (such as co-workers talking about their  respective wage rates). The Executive Order, effective on  April 8, 2014, allows agencies to terminate contracts where  the contractor discriminates against or penalizes employees  who discuss among themselves their compensation data.  The National Labor Relations Act (“NLRA”) grants  employees the right to discuss the terms and conditions of  their employment for the purpose of collective bargaining,  and prohibits employers from interfering with that right.   29 U.S.C. §§ 157-58. The NLRA does not, however,   prescribe serious penalties for employer  violations; the  National Labor Relations Board (“NLRB”), which has  jurisdiction over employment disputes arising under the Act,  may order injunctive and equitable relief—including back  pay and reinstatement for wrongfully terminated  employees—but may not issue punishments such as fines  for employer violations. 29 U.S.C. § 160(c).  Given that somewhat incomplete framework, employers  routinely restrict employees from discussing compensation  with one another.  With limited exceptions, the Executive Order applies to   all government contractor employees, not just the  nonsupervisory employees covered by the NLRA. Although  the Order is technically in effect, the Department of Labor  must propose implementing regulations by September 15,  2014. Employers should take the time now to review and  revise their policies and procedures to comply with the  Order’s prohibitions and participate in the public comment  process once DOL releases the new rules.  Proposed DOD Rule Expands  Contractors’ Risk of Personal Conflicts of  Interest  Currently, the FAR includes some coverage to require  contractors to identify personal conflicts of interest (“PCI”) in  connection with contractor personnel who work on  “acquisition function[s] closely associated with inherently  governmental functions,” such as developing the work  specifications to be included in a solicitation. FAR 3.1101.  Contractors are required to maintain procedures to identify  potential PCIs, including requiring internal employee  disclosure of financial interests and managing work  assignments to ensure that covered employees are only  assigned to conflict-free projects.  On April 2, the FAR council proposed a new rule expanding  the scope of the PCI rules. 79 Fed. Reg. 18503. The  proposed rule does not materially change the existing rules,  but it does expand the definition of “covered employee” to  include those folks performing any work that is closely  associated with inherently governmental functions, such as  law enforcement activities, intelligence operations, or internal  policy development, FAR 7.503(c), and those working on  service contracts, FAR 37.104. The expanded coverage  scope is not limited to just the acquisition functions. The new  rule does not apply to commercial items or to contracts  valued below the simplified acquisition threshold ($150,000).  Even so, the FAR council estimates the new rule could affect  over 28,000 contract actions (e.g., actions resulting in a contract,  including actions for additional supplies or services outside the  existing contract scope) annually, requiring many contractors to  now implement PCI procedures for the first time.   The public comment period ended on June 2. Numerous  business groups (i.e., the U.S. Chamber of Commerce,  Aerospace Industries Association, and Professional Services  Council) commented in opposition to the new requirements.  DOD’s Restrictions on Counterfeit Parts  Rule Is Limited to Electronic Parts, but  More Changes Are Expected   On May 6, DOD issued the final version of its counterfeit  parts rule, 79 Fed. Reg. 26,092. See Baker’s July 2013  Quarterly Update. Responding to concerns of ambiguity and  overbreadth, the Final Rule is limited strictly to counterfeit  electronic parts and adds an intent requirement that the part  be “knowingly mismarked, misidentified, or otherwise  misrepresented” as a precondition for finding contractor  liability.  The Final Rule, also effective May 6, 2014, covers all prime  contractors subject to the Cost Accounting Standards,  requiring them to implement as part of their purchasing  system policies that are designed to prevent the introduction  of counterfeit parts into the supply chain. Among other things,  this requires imposition of flow-down clauses to ensure that  lower tier subcontractors also take preventative measures  Page 2  against incorporation of counterfeit electronic parts into their supply chains. Covered contractors whose purchasing  systems are found to be deficient face the possibility of having  payments withheld.   Even though DOD agreed to narrow the scope of its final rule,  contractors must remain vigilant. The FAR council released a  proposed rule on June 10, 2014 that will (if implemented as  final) expand civilian contractor responsibilities to include  proactive measures to protect against the incorporation of  counterfeit and nonconforming items. 79 Fed. Reg. 33164.  But, unlike DOD’s final rule, the proposed FAR rule will apply  to any item supplied by any contractor that is subject to FAR.  The comment period closes on August 11.   DOD’s New FOCI Rules Present New  Challenges to Contractors with Foreign  Connections   On April 9, DOD issued an interim final rule formally  implementing National Industrial Security Program (“NISP”)  regulations for companies subject to foreign ownership,  control, or influence (“FOCI”), 79 Fed. Reg. 19467, codified at 32 C.F.R. Part 117. The rule replaces the informal agency  guidance that was available through individual DOD staff  contacts and high-level provisions in the NISP Operating  Manual (“NISPOM”).  A company is considered to be under FOCI when a foreign  interest has “the power . . . to direct or decide matters affecting the management or operations of the company in a  manner that may result in unauthorized access to classified  information or may adversely affect the performance of  classified contracts.”  32 C.F.R § 117.56(b)(1); see also 79  Fed. Reg. 19472. Although various arrangements may  constitute FOCI, including contractual arrangements, the  NISP has heretofore been concerned primarily with ownership  arrangements and the attendant right to control corporate  actions. The new rule allows DSS to find FOCI when the  foreign holder of an ownership or voting interest of greater  than five percent cannot be adequately identified. 32 CFR   § 117.56(b)(3)(v). This provision may create significant  complications for complex investment vehicles such as hedge  funds, which often do not readily disclose their underlying  investors.  The new rule also clarifies the relationship between the review  of foreign acquisitions conducted by the Committee on  Foreign Investment in the United States (“CFIUS”) and the  NISP procedures. 32 C.F.R. § 117.56(b)(14); see also 79  Fed. Reg. 19473. Although the two procedures remain  separate, the rule explains that CFIUS and DSS will  coordinate their reviews and share information, increasing the  importance of a coordinated regulatory strategy for companies  submitting investments from or acquisitions by foreign  interests for government review.   Would-Be Service Contractors Face  Exposure of up to $10,000 Penalty per  Day under HHS Contracts On May 12, the U.S. Department of Health and Human  Services (“HHS”) published notice of a proposed rule to  amend the civil monetary penalty (“CMP”) rules of the Office  of Inspector General (“OIG”). As part of an overhaul of 42  C.F.R. Part 1003, the OIG proposed several updates to codify  changes made by the Patient Protection and Affordable Care  Act (“PPACA”). The proposed rule would (if implemented)  expand the range of conduct subject to CMPs,  assessments, and exclusions to include:  •  Failing to grant OIG timely access to records upon  reasonable request;  •  Ordering or prescribing treatments likely to be financed  by federal programs from which one is excluded;  •  Making or causing to be made any false statement,  omission, or misrepresentation in a bid, contract, or  application;  •  Failing to report and return known overpayments; and  •  Making or using false records and statements to  support a fraudulent claim.   The proposed rule would also clarify the methodology used  for calculating penalties and assessments for utilization of  excluded employees, among other things. Of significant  potential concern is the proposed application of a default  assessment of $10,000/day as a penalty for failing to return  overpayments within 60 days of their identification.  The commenting period closed on July 11.  GAO Decides That Small Business Joint  Venture Proposals Do Not Require SBA  Pre-Approval  On May 29, the GAO ruled that joint venture agreements do  not require approval from the Small Business Administration (“SBA”) before submitting a proposal for solicitations issued  pursuant to the SBA’s 8(a) set-aside program. See BGIFiore JV, LLC, B-409520 (May 29, 2014). NASA conceded  during the protest that the SBA’s regulations do not require  pre-proposal certification, see 13 C.F.R § 124.513, but it  nonetheless argued that the FAR permits agencies to  impose more stringent standards than those required by the  SBA. FAR 52.219-18. NASA, hoping to avoid evaluation of  proposals that might later be deemed ineligible for selection,  rejected all proposals submitted by joint ventures that did  not possess SBA approval at the time of their proposal  submission. The GAO disagreed with NASA’s views, noting  that the SBA’s regulations only require a joint venture  agreement to be approved prior to the awarding of the  contract.   Of course the GAO’s decision makes complete sense from  a savings perspective. Why should SBA be required to  consider all joint ventures before bids are submitted when it  really need consider and approve only the one joint venture  that is selected for award?     Baker Team Secures Arbitration Award  for Wrongful Termination of Subcontract  On July 9, a panel of three arbitrators issued an arbitration  decision awarding Baker’s client, a small business under  subcontract to furnish nursing personnel at the Tripler Army  Medical Center (“TAMC”), approximately $2 million for the  prime contractor’s wrongful termination of the subcontract  18 months before the agreed-upon expiration date. The  award capped a 15-month arbitration proceeding that  culminated in a 10-day hearing.  Page 3 Code   Section Agency Regulation Description Lastest   Action Effective  Date 48 CFR Parts  1, 4, 12, 22,  and 52  DOD,  GSA,  NASA  To amend the FAR to require the use of Commercial and Government Entity  (“CAGE”) codes, including North Atlantic Treaty Organization  codes (“NCAGE”) for foreign entities, for awards valued at greater than the micropurchase threshold  Final Rule 11/1/2014  48 CFR Parts  4, 42, and 52  DOD,  GSA,  NASA  To implement the Consolidated Appropriations Act, 2014, by amending the FAR  to revise the clause on Recovery Act reporting procedures and repeal the reporting requirements of the American Recovery and Reinvestment Act of 2009  Final Rule 5/30/2014  48 CFR Parts  31 and 52  DOD,  GSA,  NASA  To implement a section of the National Defense Authorization Act of 2012 by  amending the FAR to expand the application of the senior executive compensation benchmark to a broader group of contractor employees on contracts awarded by DOD, NASA, and the Coast Guard  Final Rule 5/30/2014  48 CFR Part  42  DOD,  GSA,  To amend the FAR to implement statutory changes expediting the review and  dissemination of past performance evaluations  Final Rule 7/1/2014