The Federal Acquisition Regulations’ forthcoming “integrity reporting” disclosure requirement should have federal contractors on their guard, but not running for the hills

Issue Vol. 10 No. 3 January 2008 By Benjamin B. Tymann & Peter D. McCarthy

Companies that do business with the federal government operate in an ever-intensifying regulatory and enforcement environment. The temperature is about to be turned up again with the onset of a new Federal Acquisition Regulation (“FAR”) that will add an “integrity reporting” requirement. Federal contractors and subcontractors will be expressly mandated to timely disclose to their government contracting officers any known violation of federal law relating to their contracts. Failure to so disclose could be cause for suspension or debarment. This impending new rule follows closely on the heels of FAR requirements that took effect at the end of 2007 requiring contractors and subcontractors working on federal projects of sufficient size and duration to implement compliance and ethics programs within their organizations.

Of course, determining whether or not a violation of law has actually occurred — and therefore whether a disclosure obligation exists — is easier said than done. It is therefore imperative for contractors doing business with the federal government, to commence internal investigations that are thorough, independent and protected by the attorney-client privilege immediately upon becoming aware of an allegation of internal wrongdoing. Equally as important for all federal contractors — indeed, for all but the smallest businesses, of any kind — is to put in place effective internal compliance programs that detect and deter violations of law.

I. FAR rules for contractor codes of business ethics and conduct

Recently approved Federal Acquisition Regulations, made effective on Dec. 24, 2007, require contractors and subcontractors performing certain federal contracts to:

(i) have a written code of business ethics and conduct;

(ii) provide a copy of said code to each employee;

(iii) institute an accompanying compliance training program; and

(iv) display anti-fraud hotline posters in common work areas and worksites.

See FAR 52.203-13 and FAR 52.203-14.

These business integrity measures are mandatory for government contracts that exceed $5 million and have performance periods of 120 days or more. See FAR 3.1004. Contractors selling exclusively “commercial items” are exempt from the requirements.1 In addition, certain contractors who identified themselves to the federal contract officer at the time of bidding as a small business, and who qualify as such, are also exempt from most of the new FAR rules on compliance programs.

To promote compliance with this provision, these new FAR provisions even dictate the objective of the Contractor Codes of Business Ethics and Conduct. The new FAR rule states that “contractors should have an employee business ethics and compliance training program and an internal control system that —

(1) Are suitable to the size of the company and extent of its involvement in government contracting;

(2) Facilitate timely discovery and disclosure of improper conduct in connection with government contracts; and

(3) Ensure corrective measures are promptly instituted and carried out.”

FAR 3.1002. See also FAR 52.203-13(d). These three guidelines are quite generalized and allow contractors and their advisors to tailor an effective compliance program appropriate for the particular company and industry.

II. Proposed FAR “integrity reporting” rule

During the approval process for the regulations that mandated Contractor Codes of Business Ethics and Conduct, the Department of Justice (“DOJ”) advocated for adoption of an additional anti-fraud measure — a mandatory fraud-reporting requirement for contractors and subcontractors who become aware of violations of federal criminal law with regard to government contracts or subcontracts. See 72 Fed. Reg. 64019. To avoid delay, the Civilian Agency Acquisition Council and the Defense Acquisition Regulations Council (the “councils”) carved out the proposed reporting requirement from the Code of Business Ethics and Conduct rules that took effect on Dec. 24, 2007. See id. The councils then submitted the reporting measure for public consideration as a separate proposed rule. See 73 Fed. Reg. 28407.

A. Elements of new proposed rule

Following the earlier DOJ recommendation, the councils published FAR Case 2007-006 “Contractor Compliance Program and Integrity Reporting” in the Federal Register on Nov. 14, 2007. See 73 Fed. Reg. 28407. The “compliance program” part of the rule would require contractors to establish and maintain internal controls to detect and prevent fraud in connection with the award or performance of government contracts or subcontracts. The “integrity reporting” part of the rule would impose a mandatory disclosure requirement on government contractors and subcontractors who become aware of violations of federal criminal law. The mandatory disclosure requirement is necessary, according to the DOJ, because few companies voluntarily report suspected instances of federal criminal violations relating to contracts or subcontracts. See 72 Fed. Reg. 64020.

To implement the DOJ request, the councils proposed modifying FAR Subpart 9.4 (governing the grounds for debarment or suspension of government contractors) to include, as punishable offenses, “knowing failure to timely disclose” either (i) an overpayment on a government contract or (ii) a violation of federal criminal law in connection with the award or performance of a contract or subcontract. See 72 Fed. Reg. 64022. The councils also proposed inserting the following clause into the (recently enacted) Code of Business Ethics requirement at FAR Subpart 52.203-13: “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 subcontractor of the Contractor has committed a violation of Federal law ….” See 72 Fed. Reg. 64022 (emphasis added).

This does not mean that it is required or advisable for a contractor to report every alleged violation of law that comes to its attention to the government. On the contrary, for a contractor to responsibly determine whether or not it has “reasonable grounds to believe” that a violation of law has actually occurred, it must exercise due diligence and internally investigate the facts and circumstances of the alleged events at hand, and to seek legal advice as to whether the most likely set of facts form a reasonable basis to believe a violation of law occurred. Ideally, contractors should utilize outside counsel both to lead the internal investigation — to ensure independence, thoroughness, and protection of the attorney-client privilege at least until the time a disclosure decision is made — and, of course, to furnish the legal advice.

But just as it is important for contractors not to succumb to skittishness or governmental pressure and disclose every allegation of wrongdoing, it is critical that contractors not ignore violations of law that could be occurring in their own organizations, or to turn a blind eye to fraud or other wrongdoing in their midst. Implementing robust internal controls and compliance programs — programs that are even more robust, in most cases, than the minimum Code of Business Ethics elements set forth in the FAR — is cost-effective insurance against the type of corporate inattention that can allow internal wrongdoing to fester and grow.

B. Even violations of the civil false claims act may be subject to mandatory disclosure

On May 16, 2008, the councils published public comments and suggested changes to the first proposed rule in the Federal Register.2 See 73 Fed. Reg. 28407. Among the recommendations, the DOJ proposed to increase the scope and stringency of the mandatory reporting requirement by requiring contractors to report violations of the civil False Claims Act (31 U.S.C. 3729-3733) in addition to criminal violations. See id. The proposal would make knowing failure to report such civil violations a cause for debarment or suspension under FAR Subpart 9.4. See 73 Fed. Reg. 28408.

As with the proposed FAR rule about mandatory reporting of criminal violations, “evidence of knowing failure [by contractors] to timely disclose civil False Claims Act violations in connection with government contracts” could result in debarment or suspension from government work pursuant to FAR Subpart 9.4. See 73 Fed. Reg. 28409. And as with the proposed rule about criminal violations, FAR Subpart 52.203-13 would be modified to require contractors to notify the OIG and the government contracting officer whenever contractors have reasonable grounds to believe a civil violation has occurred. See id. The review standard would be by preponderance of evidence of a knowing failure to report. See id.

On November 12, 2008, the Federal Register published the final “integrity reporting” rule, and made it effective December 12, 2008. One noteworthy revision from the language of the proposed rule: the much-criticized “reasonable grounds to believe” standard triggering the disclosure obligation was changed to a “credible evidence” standard instead. The disclosure applies to all federal contracts, not just those exceeding $5 million and 120 days in duration. In sum, the final rule requires any federal contractor or subcontractor to disclose to the relevant federal agency’s Office of Inspector General credible evidence of (a) federal criminal law violations involving fraud, conflict of interest, bribery or gratuities; (b) violations of the civil False Claims Act; or (c) significant overpayment on the contract.

III. Conclusion

Criminalizing federal contractors’ failure to disclose violations of criminal and even civil laws ratchets up an already intensive enforcement apparatus for those who do business with the federal government. Some contractors may thus shy away from federal work altogether, and some may be inclined against their better judgment to report every allegation of wrongdoing to the government. Neither is a wise approach. Instead, contractors can both honestly prosper in their federal work and faithfully execute all of their duties under their federal contracts — especially these forthcoming disclosure duties — by implementing an effective compliance program and exercising the judgment to promptly commence a through, independent and attorney-client privileged internal investigation upon becoming aware of an allegation of wrongdoing.

End notes

1.    The FAR defines a “commercial item” as “any item, other than real property, that is of a type customarily used by the general public or by non-governmental entities for purposes other than for governmental purposes, and (i) has been sold, leased or licensed to the general public; or, (ii) has been offered for sale, lease, or license to the general public.” FAR 2.101.

2.    FAR Case 2007-006 now officially contains “2nd Proposed Rule” in its title. Note that only new proposed changes were republished in the May 16, 2008, Federal Register