Cutting Costs Does Not Require Cutting Compliance

By David Hickey
Defense contractors face tremendous cost pressures as government customers face huge budget cuts. While defense budget reductions are inevitable, the extent and nature of proposed cuts varies by hundreds of millions of dollars and impacts all budget areas, including procurement, health care costs and retirement.   

This cost-cutting, revenue-seeking environment increases the importance of contractor compliance. Lest anyone think the federal government will tolerate less contractor compliance, the current environment indicates that it is much more likely that the government will pursue allegations of non-compliance, fraud, waste and abuse with even greater vigor.  

The Congressional Commission on Wartime Contracting recently concluded that more than $31 billion in taxpayer dollars had been lost to contract waste and fraud under reconstruction, logistics and security contracts in Iraq and Afghanistan. Reforms such as mandatory debarment are being proposed as a result.

A similar environment existed during the last defense spending peak, when the Justice Department’s Operation Ill Wind uncovered pervasive corruption by U.S. government officials and contractors. At that time, a perception of corruption surrounded the defense industry and compliance costs increased for all.

Unsurprisingly, federal agencies have placed renewed emphasis on reporting mechanisms such as the Securities and Exchange Commission’s Dodd-Frank program, and the IRS’ Whistleblower Reward Program, which have yielded more than $7.3 billion in False Claims Act settlements since January 2009.

At the heart of these efforts is the common perception that the government’s efforts to detect and prevent fraud, waste and abuse have failed to keep pace with the amount spent on federal contracting.

Contracting fraud is in the spotlight.  Contractors that complement competitive competence with the highest standards of compliance will enjoy a critical advantage going forward. Those that sacrifice compliance inevitably will pay a steep price.

Balancing cost and compliance needs means satisfying certain “minimums” set forth by law, regulation and good business sense. The legal standard for compliance is strict, but contractors are permitted some discretion in how they implement it. The Federal Acquisition Regulation (FAR) requires each contractor to implement a business ethics awareness and compliance program and internal control system “suitable to the size of the company and extent of its involvement in government contracting.” Though the FAR describes the condition of compliance with specificity, contractors determine the optimal allocation of resources.

Given limited manpower and strained finances, contractors should allocate compliance resources only after fully analyzing their own particular areas of risk. For example, the discovery and disclosure of questionable conduct — a central element of any compliance program — will be more difficult for contractors facing fiscal pressures. When jobs and business opportunities are scarce, the risk of misconduct may increase because some employees may operate out of fear rather than virtue. Responding to this requires vigilance by company leadership. Mandatory disclosures are far less painful and costly than undetected corporate wrongdoing, which can literally destroy a contractor.

Contractors seeking to enhance their own compliance programs should focus on affordable, yet high-impact, improvements.

Satisfactory answers to the following questions can be helpful:  
Is the ethics code accessible to employees?  How often are employees trained? Are all appropriate communication resources used to support a compliance program?

Is the code supported by meaningful policies, procedures, standards and guidance on specific requirements and conduct? Are routine internal audits or risk assessments performed? What are the high-risk subject areas? Are action plans developed to mitigate high-risk areas? What resources are dedicated to conduct company internal investigations when credible allegations arise?

What internal reporting mechanisms are available to employees to report concerns?  Does the company provide an employee hotline that allows for anonymity and confidentiality? Is the hotline actually used from time to time, thereby validating its efficacy?  How are whistleblowers protected?

What motivates, or de-motivates, an employee to report concerns?

What are the company’s procedures for self-reporting externally in the event of evidence of false claims, fraud, conflict of interest, bribery, gratuities or significant overpayments?

Does the company encourage full cooperation with government investigations and legal proceedings?

What position does the compliance or ethics officer hold in the company? What is the tone from the top?  

Consideration of these issues is appropriate for companies of all sizes.  Effective compliance is equally important for small and medium-sized businesses, many having participated in the defense marketplace as subcontractors, but are now serving for the first time as prime contractors.

The transition from subcontractor to prime contractor can bring with it new and often unexpected requirements. For such “first-time primes,” the National Defense Industrial Association’s Ethics Source is a useful framework and resource.  

Much has changed since NDIA unveiled its Code of Ethics seven years ago. Troop levels in Iraq and Afghanistan then approached 170,000; next year, force levels are projected to be significantly lower. As of March 2011, the Defense Department had more contractor personnel in Afghanistan and Iraq than uniformed personnel. With projected drawdowns and upcoming defense budget cuts, contractors will need to find ways to remain legally compliant, fiscally responsible and commercially viable. Making money to increase shareholder value is a fiduciary obligation; so too is keeping it.

Despite significant fiscal pressures and the compliance environment, the principles set forth in the NDIA Ethics Code remain unchanged. Shrinking budgets require greater efficiency, but cutting corners in ethics and compliance inevitably will cost much more than the savings were worth. Those that thrive in this challenging environment will do so because they effectively and efficiently manage both fiscal and reputational resources.

David Hickey (hickeyd@gtlaw.com) is a shareholder in Greenberg Traurig LLP’s government contracts practice groups. The views expressed are solely those of the author.

Topics: Defense Contracting, Defense Contracting

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