Government Contractors to Face Tough New Mandatory Disclosure Requirements
November 25, 2008
New Mandatory Disclosure Requirement: The new rule mandates the timely disclosure to the awarding agency Office of Inspector General whenever the contractor has “credible evidence” of the violation of certain federal criminal laws or the civil False Claims Act in connection with the award, performance, or closeout of a government contract performed by the contractor or a subcontractor.
New Internal Controls Requirement: The rule requires contractors to implement internal controls to detect and prevent improper conduct in connection with the award and performance of any Government contract and subcontract.
New Grounds for Suspension & Debarment: The rule also establishes new grounds for suspension and debarment -- the “knowing failure” by a “principal” of a government contractor to timely disclose to the government the (a) violation of federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations; (b) violation of the civil False Claims Act; or (c) significant overpayments on the contract. The rule applies to violations related to any government contract performed by the contractor or subcontractor and discovered within three years of final payment.
5 Major Changes from the Proposed Rules
1. Closes the “loophole” – The final rule covers contracts performed entirely outside the United Statesand commercial item contracts. After such contracts were exempted from the initial proposed rule, Congress passed the “Close the Contractor Fraud Loophole Act,” Public Law 110-252, Title VI, Chapter 1, mandating their inclusion in the final rule.
2. Imposes a “credible evidence” standard – In response to the perceived vagueness of the original proposed standard, the FAR Councils increased the level of knowledge that requires disclosure from “reasonable grounds to believe” to “credible evidence.” This higher standard affords the contractor the opportunity to conduct a preliminary examination of the evidence to determine its credibility before deciding to disclose to the Government.
3. Defines “criminal violation” – The final rule provides a more precise definition of the crimes triggering the mandatory reporting obligation, making clear that only crimes typically related to the performance of government contracts are covered. Such crimes include fraud, conflict of interest, bribery, and gratuity violations, as well as violations of the civil False Claims Act.
4. Imposes suspension or debarment for specified individuals’ failure to disclose – The proposed rules would have permitted suspension and debarment for an employee’s known failure to disclose wrongdoing. Under the final rule, only a “principal’s” failure to disclose triggers this penalty. The rule broadly defines “principal” to include not only officers, directors, owners, and partners, but also personnel having primary management or supervisory responsibilities within the contractor.
5. Extends obligations to small businesses – Whereas small businesses retain their exemption from the requirements for internal compliance systems and formal training programs, under the new rule they are subject to the mandatory disclosure obligation.
5 Lingering Questions
1. Interpretation of legal standards – Although the final rule attempts to remove some of the vagaries of previously proposed rules, it remains to be seen how agencies will interpret their new duties. For example, the use of the term “credible evidence” strongly suggests that the contractor needs more than mere suspicion before disclosure is required. The “knowing failure” to disclose standard is unclear, but the use of the term “timely disclosure” suggests that some investigation is required. The depth of the investigation and the degree of certainty required for disclosure are still imprecise.
2. Impact on subcontractors – The new rule may require prime and subcontractors to monitor each other during contract performance. However, without a meaningful ability to investigate relevant facts and circumstances within another entity’s organization, it is unlikely that subcontractors will ever have “credible evidence” regarding prime contractors’ wrongdoings – and vice versa. The requirement to disclose another company’s perceived violations may complicate business relations and contract performance.
3. Effectiveness – There remains concern that some contractors will lack the incentive to follow the new rule. It is conceivable the only contractors that will comply with the new requirements will be the responsible contractors who would have self-reported under the previous system.
4. Agency capacity – Some contractors may report all instances of potential crimes or fraud -- flooding agency inspector generals with “trivialities” out of fear of potential repercussions. If this happens, agencies may lack the resources to investigate each disclosure.
5. Privacy concerns – Mandatory disclosure requirements threaten employees’ Fifth Amendment right against compelled self-incrimination and may weaken the attorney-client privilege. Contractors will be required to fully cooperate with government investigations, potentially exposing the company to government scrutiny of business records. It is unclear how confidential information will be treated when it is turned over to the government.
No matter how the rule is enforced, it clearly imposes new compliance obligations on government contractors that make it critical to establish standards and procedures for discovery of improper conduct in connection with government contracts and timely disclosure to appropriate government authorities. As a result of this rule, contractors may need assistance developing strategies for vigorous investigation of reported misconduct and devising new recordkeeping systems to document reports and corrective action. Contractors need independent judgment in setting up a compliance system that meets the emerging legal requirements in light of the contractor’s unique conduct and circumstances.