New Mandatory Disclosure Rule

The New Rule

The new rule has been codified at FAR 3.1003 (it also established new contract clauses with similar provisions, which this article does not address). The Federal Register notice promulgating the rule also contains helpful interpretive information. 73 Fed. Reg. 67,064 (Nov. 12, 2008).

Key provisions of the Regulation require that:

• All holders of federal government contracts must disclose to the government when a “principal” has “credible evidence” of civil or criminal fraud or corruption related to the award or performance of a federal government contract. The disclosure must be made both to the inspector general (IG) of the cognizant contracting agency and to the contracting officer (CO). “Principal” includes persons having supervisory responsibilities within the organization. A principal's knowing failure to disclose can result in suspension or debarment of the contractor.
• Contractors must disclose to the CO, but not the IG, when a principal has knowledge of a “significant” overpayment.
• Contractors must also disclose improprieties of their subcontractors. After disclosure, contractors must provide “full cooperation,” which entails providing information sufficient to identify the nature and extent of the offense and the individuals responsible, timely and complete responses to government requests for documents, and granting government access to employees.
• The rule covers contracts for purely commercial products and services and contracts performed outside the United States, and imposes additional specific requirements for internal compliance, training programs, and enhanced internal controls for certain contracts.

Questions

The new Regulation raises many questions. How do you determine whether events are reportable as fraud? When must you make the disclosure? How do traditional internal investigation and advocacy fit into all this?

What Sort of Conduct Is Disclosable?

Five categories of violations must be disclosed: violations of the civil False Claims Act, fraud, conflict of interest, and bribery or gratuities in violation of the federal criminal code (18 U.S.C.). This short list has a broad reach. False statements, 18 U.S.C. ' 1001, along with the civil False Claims Act, 31 U.S.C. ' 3729, are routinely used to penalize the most common forms of fraudulent procurement activity, including:

• delivery of substandard products and services;
• labor hour mischarging;
• non-compliance with government contract accounting rules;
• non-compliance with cost or pricing data submission requirements of the Truth in Negotiations Act, 10 U.S.C. ' 2306(a), 41 U.S.C. ' 254(d); and
• violation of the Procurement Integrity Act, 41 U.S.C. ' 423.

Undisclosed conflicts of interest subject to FAR Part 9.500 could also require reporting if a contract has been awarded following their non-disclosure. The Regulation may also require disclosure of “incomplete” offenses ' for instance, attempts and conspiracy.

When Does the Disclosure Obligation Arise?

The Regulation does not state a time frame for disclosure; only that it be “timely.” But since a principal's knowing failure to make a timely disclosure is grounds for suspension and debarment, it goes without saying that contractors need to understand what “timely” means.

The Regulation requires disclosure when “credible evidence” is known to a principal. This is not a time frame, but a threshold at which disclosure becomes necessary. This threshold is intended to permit the contractor to have the opportunity “to take some time for preliminary examination of the evidence to determine its credibility before deciding to disclose to the Government.” 73 Fed. Reg. 67,073. Unfortunately, “credible evidence” isn't defined in the Regulation, either. A reasonable position would be to view credible evidence as established where the available facts, in light of the surrounding circumstances (e.g., the source of information, knowledge and credibility of witnesses, documents), would cause a reasonable person to believe that a violation occurred or is more likely than not to have occurred. It is a significantly lower threshold than the one at which many contractors would likely choose to make a voluntary self-disclosure. Indeed, at the time a disclosure becomes ripe under the new Regulation, much internal investigation may remain to be done.

The Ultimate Test

Faced with the inevitable tough call, the ultimate test is whether a non-disclosure decision will seem reasonable when second-guessed in retrospect by agency suspension and debarment officials. If the contractor's decision not to disclose was reasonable at the time, and other criteria in the FAR (see ' 9.406) do not warrant debarment, the contractor should be safe from regulatory sanction, even if an offense is later proven or admitted.

So is it time, in our hypothetical, to disclose the information you just received? Probably not. You know virtually nothing about the supposed under-testing. You don't know exactly which employees were involved, whether documents may have been falsified, or even whether affected parts were sold to the government. Even assuming the information is generally credible, further investigation is required. And that is where things become more complicated.

How do you conduct an investigation ethically while preserving privilege and not waiving defenses?

To protect both the company and employee, experienced counsel begins employee interviews by explaining the ground rules that govern application of the attorney-client privilege: he or she represents the company, not the individual employee; the communication is privileged; the company, as holder of the privilege, has sole discretion to waive it. See Model Rules of Professional Conduct 1.13(f) and 4.3.

But rules of professional ethics likely require these warnings to be supplemented to include fair notice of the mandatory disclosure provision. See, e.g., Model Rule of Professional Conduct 4.1(a) (truthfulness in statements to others); United States v. Int'l Bhd. of Teamsters, 119 F.3d 210, 217 (2d Cir. 1997) (attorneys should highlight potential conflicts to all interested persons as early as possible). Without enhanced warnings, the employee could think that the company totally controls to what extent it will protect the interview under the company's attorney-client privilege ' a belief that, to whatever extent it may have been true following issuance of the Thompson memorandum, is no longer completely true.

Enhanced warnings may understandably chill an employee's willingness to cooperate. Even though employees generally must cooperate with an employer, a “talk or walk” policy in the context of mandatory disclosure could raise issues of individual rights and state action. This adds a layer of constitutional concerns to internal company investigations and any resultant prosecutions. Indeed, “state action” inferred from the actions of a private party done at the insistence of the government recently torpedoed the prosecution of former KPMG partners in United States v. Stein, 541 F.3d 130 (2d Cir. 2008). The government would deny that the corporation becomes an agent of the state in carrying out its obligations under the Regulation. See 73 Fed. Reg. 67,077. However, the effect of compliance with the Regulation on employee rights is just one aspect of the new Regulation that will prove complex for companies, their counsel, and the government ' and it will likely be well-litigated.

Back to our hypothetical: You interview employees, who cooperate even though you've told them of the company's mandatory disclosure obligations. You learn that test records were sometimes altered to indicate falsely that testing occurred at required intervals. You learn that the parts were for government programs, and you can identify the programs. You review the applicable contracts and determine that they require testing at specified intervals. You decide that disclosure is required.

But what about privilege? The Regulation professes not to require waiver. 73 Fed. Reg. at 67,077. But it also demands “full cooperation.” In practice, it will be rare when a satisfactory disclosure can be made without some disclosure of information developed with the involvement of counsel.

Selective disclosure to the government of attorney-client privileged information has always been dicey, risking wholesale subject matter waiver. The new Rule 502 of the Federal Rules of Evidence enacted last September purports to limit the scope of waiver when privileged information is intentionally disclosed to the federal government. Its plain language indicates that this protection applies when contractors make disclosures of information from privileged internal investigations.

But care is required. In our hypothetical situation, you should disclose only the facts (the who, what, where, when, why, how, etc.) about the apparent under-testing. Avoid quoting or paraphrasing witness statements or otherwise disclosing or referring to the existence of privileged communications. Leave out counsel's opinion and any interpretations of the disclosed facts.

Conclusion

In sum, the new Regulation requiring prompt disclosure on pain of suspension and debarment increases the stakes and pace of internal investigations and may influence how they must be conducted. Companies and counsel must be careful to make disclosures in a way that satisfies fully the new requirements without making unnecessary admissions or otherwise compromising the company's ability to defend subsequent legal actions.

Michael Scheininger ([email protected]) is a partner and Jason Silverman ([email protected]) is an associate at McKenna Long & Aldridge LLP in Washington, DC.

You're in-house counsel at an aerospace components manufacturer supplying the federal government. A supervisor in your quality assurance group has just told you that he believes some workers in his group have not been performing tests on components at the intervals required. The details are sketchy, based mainly on overheard conversations.

Normally, your next steps would be pretty clear: issue a document hold, gather records, interview employees (careful to advise them that your communications with them are privileged), and then, based on the evidence and the company's assessment of risks and benefits, determine the appropriate course of action, possibly including a voluntary disclosure.

But since Dec. 12, 2008, the ability of company counsel to make such independent judgments and to advocate on behalf of their clients has been co-opted. That was the effective date of an amendment to the Federal Acquisition Regulation (FAR), which covers almost anyone who contracts to provide products or services to the federal government. The amended rule requires mandatory self-disclosure for government contractors under certain conditions on pain of suspension or debarment. This, in turn, has implications for how internal investigations are conducted.

The New Rule

The new rule has been codified at FAR 3.1003 (it also established new contract clauses with similar provisions, which this article does not address). The Federal Register notice promulgating the rule also contains helpful interpretive information. 73 Fed. Reg. 67,064 (Nov. 12, 2008).

Key provisions of the Regulation require that:

• All holders of federal government contracts must disclose to the government when a “principal” has “credible evidence” of civil or criminal fraud or corruption related to the award or performance of a federal government contract. The disclosure must be made both to the inspector general (IG) of the cognizant contracting agency and to the contracting officer (CO). “Principal” includes persons having supervisory responsibilities within the organization. A principal's knowing failure to disclose can result in suspension or debarment of the contractor.
• Contractors must disclose to the CO, but not the IG, when a principal has knowledge of a “significant” overpayment.
• Contractors must also disclose improprieties of their subcontractors. After disclosure, contractors must provide “full cooperation,” which entails providing information sufficient to identify the nature and extent of the offense and the individuals responsible, timely and complete responses to government requests for documents, and granting government access to employees.
• The rule covers contracts for purely commercial products and services and contracts performed outside the United States, and imposes additional specific requirements for internal compliance, training programs, and enhanced internal controls for certain contracts.

Questions

The new Regulation raises many questions. How do you determine whether events are reportable as fraud? When must you make the disclosure? How do traditional internal investigation and advocacy fit into all this?

What Sort of Conduct Is Disclosable?

Five categories of violations must be disclosed: violations of the civil False Claims Act, fraud, conflict of interest, and bribery or gratuities in violation of the federal criminal code (18 U.S.C.). This short list has a broad reach. False statements, 18 U.S.C. ' 1001, along with the civil False Claims Act, 31 U.S.C. ' 3729, are routinely used to penalize the most common forms of fraudulent procurement activity, including:

• delivery of substandard products and services;
• labor hour mischarging;
• non-compliance with government contract accounting rules;
• non-compliance with cost or pricing data submission requirements of the Truth in Negotiations Act, 10 U.S.C. ' 2306(a), 41 U.S.C. ' 254(d); and
• violation of the Procurement Integrity Act, 41 U.S.C. ' 423.

Undisclosed conflicts of interest subject to FAR Part 9.500 could also require reporting if a contract has been awarded following their non-disclosure. The Regulation may also require disclosure of “incomplete” offenses ' for instance, attempts and conspiracy.

When Does the Disclosure Obligation Arise?

The Regulation does not state a time frame for disclosure; only that it be “timely.” But since a principal's knowing failure to make a timely disclosure is grounds for suspension and debarment, it goes without saying that contractors need to understand what “timely” means.

The Regulation requires disclosure when “credible evidence” is known to a principal. This is not a time frame, but a threshold at which disclosure becomes necessary. This threshold is intended to permit the contractor to have the opportunity “to take some time for preliminary examination of the evidence to determine its credibility before deciding to disclose to the Government.” 73 Fed. Reg. 67,073. Unfortunately, “credible evidence” isn't defined in the Regulation, either. A reasonable position would be to view credible evidence as established where the available facts, in light of the surrounding circumstances (e.g., the source of information, knowledge and credibility of witnesses, documents), would cause a reasonable person to believe that a violation occurred or is more likely than not to have occurred. It is a significantly lower threshold than the one at which many contractors would likely choose to make a voluntary self-disclosure. Indeed, at the time a disclosure becomes ripe under the new Regulation, much internal investigation may remain to be done.

The Ultimate Test

Faced with the inevitable tough call, the ultimate test is whether a non-disclosure decision will seem reasonable when second-guessed in retrospect by agency suspension and debarment officials. If the contractor's decision not to disclose was reasonable at the time, and other criteria in the FAR (see ' 9.406) do not warrant debarment, the contractor should be safe from regulatory sanction, even if an offense is later proven or admitted.

So is it time, in our hypothetical, to disclose the information you just received? Probably not. You know virtually nothing about the supposed under-testing. You don't know exactly which employees were involved, whether documents may have been falsified, or even whether affected parts were sold to the government. Even assuming the information is generally credible, further investigation is required. And that is where things become more complicated.

How do you conduct an investigation ethically while preserving privilege and not waiving defenses?

To protect both the company and employee, experienced counsel begins employee interviews by explaining the ground rules that govern application of the attorney-client privilege: he or she represents the company, not the individual employee; the communication is privileged; the company, as holder of the privilege, has sole discretion to waive it. See Model Rules of Professional Conduct 1.13(f) and 4.3.

But rules of professional ethics likely require these warnings to be supplemented to include fair notice of the mandatory disclosure provision. See, e.g., Model Rule of Professional Conduct 4.1(a) (truthfulness in statements to others); United States v. Int'l Bhd. of Teamsters , 119 F.3d 210, 217 (2d Cir. 1997) (attorneys should highlight potential conflicts to all interested persons as early as possible). Without enhanced warnings, the employee could think that the company totally controls to what extent it will protect the interview under the company's attorney-client privilege ' a belief that, to whatever extent it may have been true following issuance of the Thompson memorandum, is no longer completely true.

Enhanced warnings may understandably chill an employee's willingness to cooperate. Even though employees generally must cooperate with an employer, a “talk or walk” policy in the context of mandatory disclosure could raise issues of individual rights and state action. This adds a layer of constitutional concerns to internal company investigations and any resultant prosecutions. Indeed, “state action” inferred from the actions of a private party done at the insistence of the government recently torpedoed the prosecution of former KPMG partners in United States v. Stein , 541 F.3d 130 (2d Cir. 2008). The government would deny that the corporation becomes an agent of the state in carrying out its obligations under the Regulation. See 73 Fed. Reg. 67,077. However, the effect of compliance with the Regulation on employee rights is just one aspect of the new Regulation that will prove complex for companies, their counsel, and the government ' and it will likely be well-litigated.

Back to our hypothetical: You interview employees, who cooperate even though you've told them of the company's mandatory disclosure obligations. You learn that test records were sometimes altered to indicate falsely that testing occurred at required intervals. You learn that the parts were for government programs, and you can identify the programs. You review the applicable contracts and determine that they require testing at specified intervals. You decide that disclosure is required.

But what about privilege? The Regulation professes not to require waiver. 73 Fed. Reg. at 67,077. But it also demands “full cooperation.” In practice, it will be rare when a satisfactory disclosure can be made without some disclosure of information developed with the involvement of counsel.

Selective disclosure to the government of attorney-client privileged information has always been dicey, risking wholesale subject matter waiver. The new Rule 502 of the Federal Rules of Evidence enacted last September purports to limit the scope of waiver when privileged information is intentionally disclosed to the federal government. Its plain language indicates that this protection applies when contractors make disclosures of information from privileged internal investigations.

But care is required. In our hypothetical situation, you should disclose only the facts (the who, what, where, when, why, how, etc.) about the apparent under-testing. Avoid quoting or paraphrasing witness statements or otherwise disclosing or referring to the existence of privileged communications. Leave out counsel's opinion and any interpretations of the disclosed facts.

Conclusion

In sum, the new Regulation requiring prompt disclosure on pain of suspension and debarment increases the stakes and pace of internal investigations and may influence how they must be conducted. Companies and counsel must be careful to make disclosures in a way that satisfies fully the new requirements without making unnecessary admissions or otherwise compromising the company's ability to defend subsequent legal actions.

Michael Scheininger ([email protected]) is a partner and Jason Silverman ([email protected]) is an associate at McKenna Long & Aldridge LLP in Washington, DC.