The FAR Council has proposed new rules that would require government contractors to implement robust new compliance programs or enhance existing programs. In addition, contractors would face suspension and debarment for failure to report criminal conduct that they have a “reasonable basis” to believe exists. The proposed regulation has come under fire from both industry groups, who argue that it is unnecessary, vague, and inconsistent with other procurement laws, and other interested parties, who argue, conversely, that it is too narrow in scope and should impose stricter ethical standards on contractors.
Thus far, the Public Contract Law Section of the American Bar Association has offered the most extensive critique of the proposed ethics rules that we have found. Therefore, we use these comments as a guide to engage the issues worthy of scrutiny with regard to the proposed rules. This article sets out an overview of the proposed rule, summarizes the Section’s critique of the proposed rule, presents a scenario describing how the proposed rules would likely affect a typical situation encountered by a contractor, describes the Justice Department’s proposal for modifying the Proposed Rule to address certain weaknesses, and offers a concrete proposal for improving the proposed rule.
Overview of FAR Case 2007-006
FAR Case 2007-006 proposed new ethics compliance and disclosure rules set forth at 72 F.R. 64019 – 23 (Nov. 14, 2007) (“Proposed Rule”). The Proposed Rule includes provisions that would alter existing Federal Acquisition Regulation (“FAR”) rules regarding ethics and compliance programs in a way that is, on its face, aimed at encouraging good conduct and uncovering wrongdoing. The Proposed Rule would accomplish the following:
- Require contractors to establish and maintain a mandatory code of ethics and business conduct and internal controls
- Require contractors to notify the Inspector General and Contracting Officer whenever they have “reasonable grounds” to believe that a violation of federal criminal law has occurred in connection with the award or performance of a government contract or subcontract
- Subject contractors to suspension or debarment for any failure to “timely disclose” an “overpayment” or “[v]iolation of Federal criminal law in connection with the award or performance of any Government contract or subcontract”
Basically, the Proposed Rule encourages contractors to self-police by making the consequences for failure to detect criminal acts dire.
Problems with the Proposed Rule
The American Bar Association’s Section of Public Contract Law (“Section”) issued Comments on the Proposed Rule, which pointed out a number of weaknesses.* Initially, in the Section’s view, the FAR Council lacks statutory authority to issue a regulation calling for the mandatory disclosure of criminal acts. In addition, the Section perceived a number of other shortcomings with the Proposed Rule.
First, the Section pointed out that the explanations offered for why the Proposed Rule is needed do not seem to have any empirical basis. The Proposed Rule offers a few broad statements indicating that, in the opinion of the Justice Department, few companies are voluntarily reporting violations of procurement law. The Section questioned the factual basis for the proposition that contractors are not voluntarily disclosing compliance breakdowns, noting that in the past 20 years, voluntary disclosures have not decreased significantly.
The Section noted that the FAR creates an incentive for contractors to voluntarily disclose breaches of procurement law by treating such disclosure as a mitigating factor in considering whether to suspend or debar contractors. This regime has been in place since 1986. Moreover, argued the Section, government contractors’ compliance programs have become more robust during this time, and contractors are more likely to maintain compliance, which accounts for any decrease in voluntary disclosures that may have occurred.
Second, the Section expressed concern that the Proposed Rule overlaps and is inconsistent with existing disclosure regimes. Specifically, as mentioned above, the FAR currently provides that a contractor’s self-reporting of wrongdoing can be a mitigating factor in suspension and debarment determinations. The Proposed Rule would essentially eliminate this incentive by making self-reporting mandatory. In other words, as a logical matter, if the Proposed Rule is in effect, there no longer is such a thing as “voluntary” disclosure. The Proposed Rule does not address this discrepancy or indicate whether disclosures, whether voluntary or involuntary, would mitigate penalties if the Proposed Rule were adopted.
Third, the Section pointed out that the False Claims Act already creates powerful incentives for contractors to voluntarily disclose fraudulent behavior. The Section’s Comments present a persuasive explanation for why it is far more favorable for contractors to disclose any detected wrongdoing to the government to preclude a potential relator’s ability to serve as an “original source” of such information. Early disclosure can lead to a relatively quiet resolution of any ethical or compliance issues, rather than the public and costly process involved in defending a qui tam suit.
Fourth, the Section noted that other mandatory disclosure programs cited in support of the Proposed Rule are not analogous. For example, the Anti-Kickback Act and the Foreign Corrupt Practices Act require mandatory disclosure for very specific and limited categories of activity, whereas the Proposed Rule’s mandatory disclosure covers a wide swath of conduct. In addition, mandatory reporting under Sarbanes-Oxley is required in connection with the already robust financial reporting requirements for public companies, which are reviewed at the highest levels of management. The Proposed Rule, on the other hand, imposes a “pre-emptive trigger” by requiring disclosure “whenever there is a reasonable basis to believe” a violation of procurement law has occurred.
In addition, the Proposed Rule requires that individual employees at all levels of the company must be trained to report any ethics or compliance issues to the Inspector General (and a final rule passed in November 2007 requires that posters advertising an Inspector General disclosure hotline be displayed on contractors’ premises). These measures effectively preclude the sort of objective financial reporting and management review that occur pursuant to well-established accounting procedures involved in Sarbanes-Oxley mandatory reporting. Thus, the Proposed Rule is not analogous to existing mandatory compliance laws.
Fifth, the Section pointed out that over-payments that occur are frequently the result of innocent errors or bona fide differences in opinion regarding contract terms, and do not result from the sort of culpable conduct that merits suspension or debarment. The Proposed Rule places contractors who detect slight overpayments in a gut-wrenching position. Technically, any such over-payments may be the result of criminal conduct, depending upon the state of mind of the person or persons responsible for the actions leading to the over-payments. Therefore, it would seem that a duty to report under the Proposed Rule is triggered. Subsequently, however, it may be determined that the events leading to the over-payment were innocent. Nevertheless, assuming the contractor followed the Proposed Rule to the letter, there would now exist a disclosure that could function as an admission that the contractor believed that it, or its employees, engaged in criminal conduct.
Even if the contracting unit of the agency and the contractor could quickly resolve any problems regarding over-payments, an agency’s Inspector General and the Department of Justice have the power to conduct investigations and begin suspension and debarment proceedings, thereby imposing substantial costs on the contractor and upsetting the relationship between the contracting unit and the contractor. While the Inspector General and Department of Justice may offer assurances that this scenario would not occur under the Proposed Rule, experience with contractor clients involved in False Claims Act litigation and investigations suggests that zealous pursuit of cases involving even innocent and minor over-payments may occur. Thus, the Sections’ Comments argued that the Proposed Rule was unnecessary and would create unpredictable and potentially drastic outcomes in situations involving non-culpable conduct.
Likely Effect of the Proposed Rule in a Real-Life Scenario
Consider the following hypothetical situation: Allen works in Accounts Receivable at Contractor Corp. Allen attended training a few days ago, during which he learned about the recently passed Proposed Rule and learned that he and others at Contractor have a duty to report to the government any time they believe that there has been any wrongdoing. Allen understood that he is to report ethics problems like conflicts of interest or bribes to his superiors at Contractor, and that there is also a toll-free hotline that he could call to report such matters directly to the government. In fact, there is a poster with the hotline in the room where his cubicle is located. Part of Allen’s job is to review payments from various agencies for which Contractor does work to ensure that they are paid in full and to monitor Contractor’s cash flow and revenue.
One day, Allen discovers that a particular agency appears to have been billed twice for the same services rendered pursuant to a cost-reimbursement contract for IT services. In other words, Allen receives two payments and two invoices that appear to reflect the same work. Pursuant to Contractor’s government contracts compliance policy, which Allen has been trained to follow, Allen reports this issue to his manager, who in turn informs Contractor’s Director of Contracts, the individual with primary responsibility for administering government contracts and implementing Contractor’s compliance policies.
The Director of Contracts takes up the concern with the billing department. The Director of Contracts and the billing department determine that a simple administrative error has caused duplicate copies of certain bills to go to the government. The Director of Contracts calls the Contracting Specialist at the agency to immediately alert her to this matter. The Contracting Specialist reports the matter to the Contracting Officer. Meanwhile, the Director of Contracts, who has dealt with similar situations in the past, follows the routine procedures of documenting the over-billing and over-payments in a letter to the Contracting Officer, explaining how future bills will be adjusted to reflect the payments already received, taking steps to ensure that the amounts of over-payments will be deducted from future bills, and that the glitch that led to the duplicate bills has been resolved. This approach is satisfactory to the Contracting Officer, so Contractor continues to perform and life goes on.
Meanwhile, Allen has not forgotten about the incident. Moreover, even though he reported the incident to his superiors, Allen is worried, based on his training, that he might “get in trouble” in the future for failing to report this issue directly to the government. “After all,” thinks Allen, “I know that we probably submitted an incorrect bill to the government and I know, based on my training, that any incorrect bill might violate the False Claims Act. I don’t know that I am off the hook just because I told my superior—why else would they post the hotline information?”
So Allen calls the hotline and reports that Contractor may be double-billing the government. He reports that he has had Proposed Rule ethics and compliance training and is worried that there is conduct he should be reporting under the Proposed Rule.
Allen’s hotline report is forwarded to the Inspector General and the Department of Justice. After interviewing Allen and discussing the matter with the agency’s Contracting Officer, an investigation is opened to determine the scope of Contractor’s over-billing and to determine who knew about the over-billing, what they knew, and whether there was a failure to report on Contractor’s part when there were “reasonable grounds” to believe that a violation of federal criminal law had occurred. Contractor’s Director of Contracts believes that no criminal law was violated; there was simply a glitch in billing. However, technically, a violation of the criminal False Claims Act may have occurred and the incredulous prosecutors from the Inspector General’s office and the Department of Justice wonder why, if Allen thought the incident merited a “Proposed Rule” disclosure, did other personnel working within Contractor fail to make the same disclosure.
Ultimately, one hopes, a situation like this would be resolved without a time- and money-intensive investigation that wastes Contractor’s and the government’s resources. This is an example of a contractor “doing the right thing,” more or less, by reporting over-billing and reaching a fair and appropriate resolution via routine contract administration procedures. However, under the Proposed Rule, the risk of precious resources being diverted to investigate such innocuous events is real, as is the possibility that a contractor whose compliance and ethics are intact could nevertheless find itself facing suspension or debarment simply because a number of actors interpreted the Proposed Rule differently.
Alternatively, what if Contractor in this example had reported the incident to the Inspector General immediately and as a matter of course? What if every contractor began to report every deviance from compliance with procurement law and regulations, no matter how minor? Surely, neither the Inspector General nor the Department of Justice would have the resources to review all such disclosures and do a meaningful job of sorting out the cases worth investigating from those not worthy of further scrutiny. Moreover, if a company already lacks a culture of compliance such that it would hide issues such as those presented in our hypothetical, which necessarily means that the company is willing to risk False Claims Act liability and possible claims or contract termination as a result of over-billing, can we take seriously the proposition that the threat of suspension or debarment would prod the company to report breakdowns in compliance or ethics? We believe that, where contractors are not predisposed to “do the right thing,” the Proposed Rule is unlikely to lead to improved compliance. However, where a contractor is predisposed to ethical behavior, as in our example, the Proposed Rule has the potential to create waste and unduly harsh consequences where existing voluntary disclosure and contract administration procedures are sufficient.
D. Proposed Remedies
Changes Suggested by the Department of Justice – The FAR Council promulgated the Proposed Rule with the encouragement of the U.S. Department of Justice (“DOJ”). On Jan. 14, 2008, the DOJ issued a statement proposing amendments to the Proposed Rule. To some extent, the DOJ’s recommendations address the concerns raised above.
The first amendment the DOJ proposed was to eliminate an exception in the Proposed Rule that would apply to contracts to be performed outside the United States. The DOJ further suggested that the FAR Council modify the Proposed Rule to require disclosure of overpayments, and recommended that the Council include a materiality requirement and definition of “overpayment.” The DOJ argued that requiring reporting of overpayments would relieve contracts “from having to decide whether there is an actual criminal violation before deciding to disclose.” In addition, rather than use of the phrase “reasonable basis to believe” to trigger a disclosure duty, the DOJ suggested phrases such as “reasonable grounds to believe” or “credible information of” commission of a crime to trigger the disclosure duty. The DOJ stated that it would not oppose limiting the disclosure duty to crimes involving fraud, conflict of interest, bribery, or gratuity violations.
The DOJ suggested that the Proposed Rule should include a provision that would punish failure to disclose known violations of the False Claims Act. The DOJ did not present analysis regarding whether the disclosure provisions of the False Claims Act, which create an incentive for contractors to disclose violations to the government to avoid the possibility that another party will be the “original source” of information with standing to become a relator in a qui tam action, somehow falls short in creating a disclosure incentive. The DOJ further suggested that the Proposed Rule should include a statement that the Rule is not “intended” to require waiver of the attorney-client privilege by contractors or their employees, or waiver of any individuals’ Constitutional Fifth Amendment rights. The DOJ did not offer suggestions for mechanisms or procedures that could protect these rights in light of the mandatory disclosures for which the Proposed Rule calls. We expect that the FAR Council will afford the DOJ’s comments and suggestions considerable weight in development of a final rule.
Further Suggestion – While the DOJ’s suggestions would address problems with the Proposed Rule in part, the Proposed Rule and comments thereon lack suggestions regarding concrete procedures that could be adopted to implement the DOJ’s suggestions. The following discussion presents one such possible concrete procedure.
Commonly, when a person or company is the target of a government investigation or prosecution, a so-called “queen for a day” procedure is used to give the target an opportunity to explain his or her “side of the story” in an environment in which the government agrees that his or her statements will not be admissible in court. Under a “queen for a day” arrangement, the government typically will enter into an agreement that, in exchange for a target’s or witness’s candid testimony in an “off the record” examination, the government will not use the testimony against the witness later in court, except to impeach the witness if she contradicts her testimony. This way, the target who does not believe that she has violated the law can present his version of facts to the government while minimizing the risk that she is building the government’s case against her. This is particularly helpful when alleged violations of law involve subjective determinations regarding culpability by giving the government an opportunity to judge the credibility of the witnesses whose behavior is at issue.
The Proposed Rule, as currently drafted, pits contractor employees’ possibly differing interpretations of events against each other. If one employee determines that there is no reasonable basis to believe that a violation of federal law has occurred, but another employee feels that there is a duty to report and does so, suddenly there is evidence that someone in the company thinks that a violation of federal criminal law has occurred. Later, this may serve as an admission that could be used against the contractor. Meanwhile, others in the company may have taken steps, such as obtaining a legal opinion regarding whether there is a “reasonable basis” to believe that a crime has been committed, without reporting the conduct. In light of this difference of opinion, there is ammunition for a finding that the contractor, who has behaved responsibly and in good-faith compliance with the Proposed Rule, has, in fact, violated the Rule. In this event, the contractor would face suspension or debarment.
Incorporation of a “queen for a day” procedure, or some sort of opportunity for a confidential disclosure that cannot be used as the basis for eventual debarment or suspension, would improve the Proposed Rule by providing contractors a “safe harbor” in which to have open and candid discussions with the government regarding possible ethics or compliance breakdowns. In addition, for this proposal to be effective, the Department of Justice, and any other agencies that could bring criminal charges against contractors or individuals involved in any suspected wrongdoing, would have to be part of the disclosure process and honor the commitment not to use information learned in disclosures as a basis on which to prosecute the disclosing parties. We believe that this improvement would have the effect of diffusing situations in which a full-blown investigation or institution of suspension or debarment proceedings would not prove to be fruitful or appropriate. The procedure would accomplish this by providing the government with an opportunity to judge first-hand the credibility of the individuals whose intent will be at issue in any subsequent proceedings.
We do not question the integrity of the Inspector General and Department of Justice personnel who would review cases under the Proposed Rule. Our concern is that public unpopularity of contractors, and the misperception that contractor misconduct is systemic, will create an environment in which government officials are made to feel that they are not doing their jobs unless they mete out a certain number of suspensions and debarments, or criminal convictions, for failure to report under the Proposed Rule. This, combined with the rather subjective “reasonable grounds to believe” standard for triggering mandatory disclosure, invites uneven application and draconian consequences for non-culpable missteps by contractors.