Richard Rector | Time has come to dust off those ethics programs

Infotech & the law | Legal insights for today's market

"Not having an ethics program is no longer a wise decision for any contractor, small or otherwise." Richard Rector

Sometimes the rules change and it's no big deal. The lawyers and perhaps the accountants take notice, but the change doesn't really concern the directors, officers and executives of the company. This is not one of those times.

The federal government has proposed a rule that, for the first time, would encourage all contractors ? and require those with contracts more than $5 million and 120 days in duration ? to have formalized ethics and compliance programs. The programs would have three components: A written code of business conduct, a training system for ethics and compliance and an internal control system for detecting and disclosing improper conduct.

Small and midsize contractors would be most affected by the new rule because they often lack the type of robust procedures envisioned by the rule. And not having an ethics program is no longer a wise decision for any contractor, small or otherwise.

However, even large contractors with established compliance programs should take notice. For the first time, the rule mandates an "internal control system" for significant contracts. It also suggests certain features of a control system ? such as voluntary disclosure of all suspected violations of law ? that, if misinterpreted, are not consistent with prudent governance or existing industry practice.

The proposed rule, which was published in February, does not apply to "commercial item" contracts awarded pursuant to Federal Acquisition Regulation Part 12, or to contracts performed outside the United States. Thus, the rule will not directly affect companies that sell exclusively on a commercial item basis or perform contract work exclusively outside the United States.

Yet even these companies, like small businesses, cannot ignore the core policy and values of the rule. Having an effective ethics and compliance program is already the de facto standard for most sophisticated companies operating in the United States. This is based on guidance in the U.S. Sentencing Guidelines, Justice Department memorandums on prosecuting corporations, case law on corporate governance and responsibility, the Sarbanes-Oxley Act, and related New York Stock Exchange and NASDAQ rules.

This standard is also reflected in the rules of three federal agencies ? the Environmental Protection Agency and the Defense and Veterans Affairs departments ? which currently encourage, but do not require, contractors to maintain ethics codes and internal control systems. Indeed, the proposed FAR rule is modeled in significant part on these existing agency regulations.

Thus, the new rule arguably would memorialize what is already the standard for federal contracting and transform that de facto standard into the law for certain contractors. As a result, it would be prudent for all federal contractors to either develop an ethics and compliance program or ensure that their existing program conforms to the specific requirements of the proposed rule.

The good news in the proposed rule is that it does not dictate a one-size-fits-all solution. Rather, it recognizes that ethics training and internal control systems should be suitable to the size of the company and the extent of the company's involvement in government contracting. A key issue that contractors should evaluate is how their control systems meet the goal of reporting "any suspected violations of law" and "any other irregularities" concerning their government contracts. Although voluntary reporting of contract improprieties is often appropriate, the decision to make such reports is not automatic and should remain within the contractor's discretion.

This is one proposed rule that should be be on every contractor's radar screen.

Richard Rector is chair of the Government Contracts practice at DLA Piper US LLP in Washington, D.C. He can be reached at richard.rector@dlapiper.com.

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