The Department of Defense (DoD) issued a final rule amending the DoD FAR Supplement (DFARS) to address contractor responsibilities to detect and avoid counterfeit or suspect counterfeit electronic parts in the defense supply chain. 79 Fed Reg. 26092-01 (May 6, 2014). While the final rule provides a number of clarifications to the proposed rule, uncertainties remain for contractors who must now maintain counterfeit electronic part detection and avoidance systems in compliance with the new anti-counterfeit rules. The rule is effective May 6, 2014, and is available here.

DoD’s final rule, Detection and Avoidance of Counterfeit Electronic Parts (DFARS Case 2012-D055), partially implements Section 818 of the National Defense Authorization Act for Fiscal Year 2012 (NDAA). Section 818 imposed new requirements on DoD and the Department of Homeland Security, and requires that DoD issue comprehensive new regulations as to defense contractors that supply electronic parts or products that include electronic parts. DoD issued its proposed rule on May 16, 2013, and invited the public to submit comments. Arnold & Porter LLP previously published a summary of the proposed rule, which is available here.

The DFARS Amendments

Applicability. The final rule applies to covered contractors, which are those subject to the Cost Accounting Standards under § 26 of the Office of Federal Procurement Policy Act (41 U.S.C. § 422) and supply electronic parts or products that include electronic parts. However, covered contractors must flow down the requirements to all subcontracts at all tiers, including subcontracts for commercial items and commercial-off-the-shelf (COTS) items.

Definitions. The final rule narrows the definitions of “counterfeit part” and “suspect counterfeit part” from the proposed rule. As revised, the final rule replaces the term “counterfeit part” with “counterfeit electronic part,” thus limiting the definitions solely to electronic parts. The final rule also clarifies that “counterfeit” requires the intentional misrepresentation of a part’s authenticity, thereby addressing concerns that the proposed definition could capture genuine parts that do not perform as represented. In addition, the revised definition of “counterfeit electronic part” now specifies what constitutes a legally authorized source: the original manufacturer, current design activity, or authorized aftermarket manufacturer. Consequently, DoD has removed the definition of “legally authorized source” in the final rule. The final rule adds a new definition of “obsolete electronic part.”

DoD acknowledges in the preamble to the rule that “[i]t is not practical or cost effective to test in every case of a suspected counterfeit,”1 and has revised the definition of “suspect counterfeit part” to include a “credible evidence” standard: “Suspect counterfeit electronic part means an electronic part for which credible evidence (including, but not limited to, visual inspection or testing) provides reasonable doubt that the electronic part is authentic.”2 While this definition encompasses a fact-based approach which suggests that contractors will not need to perform exhaustive testing in each case of a suspected counterfeit part, the final rule does not elaborate on what constitutes “credible evidence” or “reasonable doubt” in the context of the counterfeit parts amendments. Contractors will thus have to make a risk- based determination on whether a suspected counterfeit part meets this new DFARS definition.

Systems. The final rule requires that covered contractors establish and maintain an “acceptable” counterfeit avoidance and detection system. The final rule provides some flexibility for contractors by specifying that these systems should include “risk-based policies and procedures” which address the following minimum criteria necessary for approval:

  • Training of personnel;
  • Inspection and testing of electronic parts, including the rapid determination of suspect counterfeit electronic parts;
  • Processes to abolish counterfeit parts proliferation;
  • Traceability of electronic parts to suppliers;
  • Use of the original manufacturer or sources with the express written authority of the original manufacturer or current design activity;
  • Reporting and quarantining of counterfeit and suspect electronic parts;
  • Detection and avoidance systems;
  • Flow down of counterfeit detection and avoidance requirements;
  • Processes for keeping continually informed of current counterfeiting information and trends; 
  • Processes for screening GIDEP reports and other credible sources of counterfeiting information; and 
  • Control of obsolete electronic parts.

In the preamble, DoD suggests that the risk level will be “based on the potential for receipt of counterfeit parts from different types of sources,” and that “the potential for counterfeit electronic items is considerably lower when the item is procured from authorized sources and retains traceability.”3 The final rule thus recognizes that “requiring the contractor to test and inspect all electronic parts would be prohibitive,” and permits contractors to make risk-based decisions “based on supply chain assurance measures.”4 The final rule, however, does not provide additional information regarding the more amorphous system requirements, such as the training of personnel and rapid determination of suspect parts or specifics on how determinations of “acceptability” will be made.

Oversight. Defense Contract Management Agency (DCMA) will monitor contractor compliance with this rule in connection with the contractor purchasing system reviews, and the final rule adds compliance obligations to the existing purchasing systems requirement. In addition, DCMA is developing a “Counterfeit Detection and Avoidance System Checklist” to provide additional guidance to contractors.5 Failure to establish and maintain an acceptable counterfeit electronic part avoidance and detection system may result in disapproval of the purchasing system and withholding of payments. DoD also proposes an alternative clause that adds systems criteria for a less comprehensive review of the contractor’s purchasing system, which targets review of those elements related to the detection and avoidance of counterfeit and suspect counterfeit electronic parts, for use in solicitations and contracts that do not include the clause present at FAR 52.244-2 (Subcontracts).

The public comments raised concerns that, based on information from the proposed rule, DCMA would not complete a first-time audit of the counterfeit parts enhancements for all covered contractors for over a decade.6 In the preamble, DoD responds by generally noting that “DCMA continually assesses its oversight obligations and modifies its priorities and assignments as required.”7 DoD’s statement, however, does not address the very real concerns raised by the commenters in response to the proposed rule, and suggests that there could be a potentially lengthy waiting period for contractors to obtain DoD approval for their systems.

Costs/Liability. The final rule maintains that contractors will be responsible for the costs of any counterfeit or suspect counterfeit parts, as well as any rework or corrective action costs that may be required to remedy the use of such parts. Per Section 833, the final rule contains a narrow exception governing when such costs may be allowable. In response to public comment on the scope of this exception, DoD clarified that it will apply only where the contractor: (i) maintains a DoD-approved counterfeit parts compliance system, (ii) receives the counterfeit parts as government- furnished property, and (iii) provides timely notice. The narrow exception offers only the slightest protection.

Conclusion. The final rule targets the significant issue of counterfeit electronic parts by requiring entities in the defense supply chain to take steps to detect and avoid such parts. These DFARS amendments, however, could have a serious financial impact on many contractors and subcontractors that must implement anti-counterfeit testing and vetting procedures. Although DoD recognizes the risks inherent in supplying obsolete parts for long life-cycle DoD systems, the regulations (and underlying statutory provisions) largely shift the burden – and resulting liability – for fighting counterfeit parts to contractors. While uncertainty remains for contractors which must now comply with this final rule, the final rule conveys DoD’s intent to pursue further government-industry dialogue on the issue of counterfeit parts, noting in the preamble that future changes to the DFARS regulations “will be considered as they are identified.”8 Contractors should therefore consider raising with DoD (directly or indirectly) ongoing issues raised by the implementation of these DFARS amendments. Contractors must also continue to be diligent in monitoring for potential counterfeit parts and any future changes to these DFARS regulations, and should take immediate steps to ensure compliance with these new anti-counterfeit rules.