Government Contracts, Investigations & International Trade Blog

Just Give Me The Facts: GAO Overturns Army Disqualification Of Awardee

Sheppard Mullin — Wed, 11 Jan 2012 12:39:10 -0800

By: Anne B. Perry

On November 21, 2011, GAO issued a rather surprising decision in which it overturned an agency's determination that an appearance of impropriety justified the termination of a contract award. Specifically, in VSE Corp., B-404833, November 21, 2011, GAO rejected the Contracting Officer's determination that VSE's use of the former government Deputy Project Manager (“DPM”) as a consultant to assist VSE in preparing its proposal created an appearance of impropriety that so tainted the procurement as to justify the termination of the contract.

The procurement sought support services for the Department of the Army's Rapid Equipping Force (“REF”). In May 2011, in a competition amongst seven offerors, VSE was awarded the contract, as the low-cost, technically acceptable offeror. CACI, one of the other offerors, filed an agency-level protest challenging the award on the basis that VSE had obtained an improper competitive advantage by virtue of the fact that it retained the Army's former DPM from the REF program to assist VSE in preparing its proposal.

Relying on ten findings, which the Contracting Officer denoted as “findings of fact,” the Contracting Officer determined that VSE's hiring of the DPM “created an appearance of impropriety” in that he had “participated personally and substantially as a Government Officer in the preparation of the REF [Alternate] Staffing solicitation” and that his work as a consultant to VSE “created the appearance of a conflict of interest,” and, thus, that there was an “appearance of impropriety” justifying the disqualification of VSE. Significantly, the Contracting Officer made these determinations notwithstanding that she could not “conclusively establish” either that the former government employee (1) “had access to competitively useful source selection information that he provided to VSE,” or (2) “violated any procurement rules or regulations,” and despite the fact that she was aware that the former government employee had been advised, in writing, by the Army ethics counselor “that he was not prohibited, under the post-employment restrictions applicable to government employees under 18 U.S.C. §207, from providing 'behind-the-scenes' activities on behalf of a contractor.” The Contracting Officer terminated the award to VSE, awarded the contract to the offeror next in line, General Dynamics Information Technology (and not CACI), and this protest by VSE followed.

GAO noted that disqualification based on an appearance of impropriety is proper without proof of an actual impropriety, but cautioned that “the determination of an unfair competitive advantage [must be] based on hard facts and not on mere innuendo or suspicion.” Moreover, it held that “[a]n unfair competitive advantage is presumed to arise where an offeror possesses competitively useful non-public information that would assist that offeror in obtaining the contract, without the need for an inquiry as to whether that information was actually utilized by the awardee.” However, agreeing with the Federal Circuit's decision in Axiom Resource Management, Inc. v. United States, 564 F.3d 1374, 1381 (Fed. Cir. 2009), GAO held that the determination of the appearance of an impropriety must be based on “hard facts” and not “on mere inference or suspicion of an actual or potential conflict.” GAO then examined each of the Contracting Officer's “findings of fact,” and determined that they were largely based on incorrect assumptions and misunderstandings of the law.

With respect to the former DPM's activities prior to retirement, the Contracting Officer concluded that the DPM had “actively participated” in the development of the REF Solicitation and “acquisition strategy,” including providing substantive comments on the draft. GAO found, however, that the Contracting Officer had assumed these facts based on her belief that the former DPM had overall responsibility for the Solicitation, attended a meeting about the Solicitation requirements, and reviewed a draft Statement of Work (“SOW”). The facts elicited during the GAO proceeding, including hearing testimony, however, showed that while the former DPM attended a meeting at which the REF requirements were discussed and was given a draft of the SOW to review, he had “minimal” involvement, his suggestions regarding the Solicitation had been rejected, the team in charge of the Solicitation did not report to him, and the draft SOW was provided to the public. GAO recognized that “a government employee's participation in the drafting of a SOW or performance work statement does not necessarily demonstrate that the employee's post-government work for an offeror created a conflict of interest where the employee's work was later released to the public as part of the solicitation.” GAO concluded, therefore, that the facts put forth by the Contracting Officer did not establish that the DPM had access to any non-public, competitively useful information or gave rise to a conflict of interest or appearance of an impropriety.

The Contracting Officer had further assumed that since the DPM had provided input to the incumbent contractor's Award Fee Board, the DPM must have had access to the incumbent contractor's proprietary information. The DPM explained that he did not have access the incumbent's cost or price information, had only provided input for the elements of performance on which he was involved, attended approximately four “round table discussions,” and did not have access to the final Award Fee determination. GAO found therefore, that the Contracting Officer's findings “relied on her assumptions, rather than hard facts,” and there also were no hard facts provided by the Agency during the protest to support the Contracting Officer's assumptions.

The only “hard fact” that GAO concluded the Contracting Officer could have determined was that the former DPM retained his government laptop until January 31, 2011, the end of the DPM's terminal leave, rather than in mid-December, when the former DPM stated that he returned the laptop. GAO found that since the former DPM's final “outprocessing” papers identified the return date as January 31, 2011, the Contracting Officer could rely on that documentation instead of the statements of the former DPM. GAO found that while the laptop theoretically could have provided the former DPM with access to a government-only files that may have contained procurement sensitive documentation, there was no evidence that such files were accessed or that such files contained procurement sensitive data. Therefore, this one fact was, in GAO's view, insufficient on which to base a finding of an appearance of impropriety.

GAO next turned to the Contracting Officer's findings with respect to the former DPM's post-employment activities. Here, the Contracting Officer had determined that the former DPM's consulting work for VSE constituted a “per se”violation of the criminal post-employment laws. The former DPM had acted as a consultant for VSE and in this capacity had reviewed its draft proposal and attended an internal VSE meeting. In this regard, as noted above, the former DPM had obtained an ethics opinion from the Army stating that it was permissible to provide “behind-the-scenes” work for a contractor. The Contracting Officer, while admitting that she did not understand what the ethic's opinion meant by “behind-the-scenes,” concluded that reviewing the draft proposal “constituted 'representing back'“ to the government and that participation in an internal VSE meeting was improper because it was “very public.” The Contracting Officer testified that “Behind-the-scenes. I don't know what he could do. I don't actually have a definition. 'Behind-the-scenes’ would mean maybe providing advice to one person, helping to write the proposal, not going forward into a meeting and stating I'm here, ask me questions.” GAO, of course, found that the Contracting Officer misunderstood the law and, thus, her determinations based on that misunderstanding were unreasonable.

Finally, GAO analyzed the Contracting Officer's determination that the former DPM's execution of a consulting and nondisclosure agreement with the Army established an appearance of impropriety. Here, the consulting and nondisclosure agreement was executed after both his retirement from the Government and the conclusion of his consulting work for VSE. Finding that the nondisclosure agreement was unrelated to the former DPM's work while a government employee and “had nothing to do with any post-employment restriction,” GAO concluded that this could not support the Contracting Officer's appearance of impropriety determination.

Notwithstanding all of the above facts and conclusions, however, GAO declined to find that the former DPM's activities were “per se permissible or that they do not raise any legitimate concerns that his hiring by VSE as a consultant creates an appearance of impropriety.” Rather, in sustaining the protest, GAO merely recommended that the Army “conduct a new review of the former DPM's role in the procurement,” and make a new determination as to whether there are any “hard facts” to support a finding of an appearance of impropriety.

While some may argue this is a cop-out, such a recommendation follows GAO's general reluctance to recommend specific awards, which is consistent with its view that it will not substitute its judgment for that of the procuring agency. Hence, GAO sent it back to the agency either to develop a better rationale supporting the disqualification or to reinstate the award to VSE. We anxiously await the Army's next step.

Authored by:

Anne B. Perry
(202) 218-6875
aperry@sheppardmullin.com

2011 Year In Review: Export Controls and Promised Reforms

Sheppard Mullin — Wed, 11 Jan 2012 11:58:40 -0800

By: David S. Gallacher

2011 was a banner year for U.S. export control laws. The Obama administration has vowed to streamline and reform the bloated U.S. export control system – promising to build "higher walls" around a narrower universe of goods and technologies requiring export licenses. Following is a summary of ten of the key reforms to U.S. export laws that took place (or were proposed) in 2011.

New Regulations

1. Consolidated List of Prohibited End-Users. In early-January 2011, the government issued a new, easier to use, "Consolidated Screening List," which combines all of the different prohibited end-user lists published by the U.S. Government (e.g., the Specially Designated Nationals List, the Entity List, the Denied Persons List, the Unverified List, and the Debarred List).

2. Loosening Encryption Controls. In January 2011, the U.S. Department of Commerce, Bureau of Industry and Security ("BIS") amended the licensing requirements for encryption controls, removing many publicly available "mass market" encryption items from jurisdiction under the Export Administration Regulations ("EAR"). See 76 Fed. Reg. 1059.

3. New STA License Exception. In June 2011, BIS created a new Strategic Trade Authorization (STA) license exception, which allows exports for certain low-risk products and technologies in certain circumstances to more than 36 countries. See 76 Fed. Reg. 35,276. BIS expects that this will eliminate the need for thousands of licenses, streamlining nearly $1.4 billion in exports.

4. ITAR Exports to Dual- and Third-Country Nationals. Effective August 2011, the International Traffic in Arms Regulation ("ITAR") authorized the export of ITAR-controlled technical data or defense articles to certain dual- and third-country nationals when a pre-screened employee is employed by an authorized company, and when effective procedures are in place to ensure that the sensitive technologies are suitably protected. See 76 Fed. Reg. 28,174.

Proposed Rules

5. Consolidation of the USML and CCL. Throughout 2011, BIS and the U.S. Department of State, Directorate of Defense Trade Controls ("DDTC") proposed a number of significant reforms that would move large numbers of products and technologies from the ITAR's U.S. Munitions List ("USML") to the EAR's Commerce Control List ("CCL"), creating a hybrid "Commerce Munitions List." The movement of these products and technologies is an intermediate step, designed (ultimately) to create a "positive control" list for both the CCL and USML that is more narrowly drawn, with the USML focused on those products and technologies that truly raise national security concerns.

In December 2010, DDTC proposed moving nearly three-quarters of the products from USML Category VII, Tanks and Other Military Vehicles, to the CCL. See 75 Fed. Reg. 76,930. These proposed rules were further updated in December 2011. See 76 Fed. Reg. 76,085, 76,100.
In May 2011, the U.S. Department of Defense and DDTC issued an interim report recommending changes to USML Category XV, Spacecraft Systems and Associated Equipment, including considering moving commercial communications satellites and related components and technologies, subject to specific exceptions, to the CCL and loosening other satellite-related restrictions.
In July 2011, BIS continued the plan to make significant revisions to the USML and CCL – proposing a new 600-series as the new Commerce Munitions List, and (among other things) adding a new ECCN as a place holder for miscellaneous items migrating off of the USML. See 76 Fed. Reg. 41,958.
In November 2011, BIS proposed new rules relating to aircraft and related items (USML Category VIII), including classification of these products and technologies on the new Commerce Munitions List. See 76 Fed. Reg. 68,675.
In December 2011, BIS proposed new classifications relating to gas turbine engines (USML Categories VI, VII or VIII). See 76 Fed. Reg. 76,072. Simultaneously, DDTC proposed the creation of a new USML Category XIX, Gas Turbine Engines, which would retain the products and technologies that are not ultimately moved to the Commerce Munitions List. See 76 Fed. Reg. 76,097.
And in late December 2011, BIS proposed new classifications relating to ships, vessels of war, and other submersibles (USML Categories VI and XX). See 76 Fed. Reg. 80,282, 80,291.
Additional changes to the USML and CCL are expected throughout 2012. The Obama administration has stated that it intends to have all of these proposed rules finalized by November 2012. While that is, no doubt, an ambitious goal, we hope that it can be accomplished.

6. Defining "Specially Designed" for Military Uses. In December 2010, DDTC proposed for the first time a definition of what it means it means to be "specially designed" for military use. See 75 Fed. Reg. 76,935. In July 2011, BIS proposed its own, lengthier definition of "specially designed." See 76 Fed. Reg. 41,958. In December 2011, DDTC acknowledged the different definitions, but indicated that they would be reconciled when a final rule is eventually issued. See 76 Fed. Reg. 76,098.

7. Exceptions For ITAR Components Incorporated into Commercial Products. In March 2011, DDTC proposed relaxing licensing requirements for ITAR components incorporated into commercial products, which would create a new de minimis exception under the ITAR. See 76 Fed. Reg. 13,928. Many foreign manufacturers simply "design out" U.S. components to avoid ITAR licensing requirements; this proposed change would attempt to limit this trend.

8. Narrowing Definition of "Defense Services" Under the ITAR. In April 2011, DDTC proposed a new rule that would narrow the definition of "defense services" to exclude publicly available information and data, even if provided in connection with defense articles. See 76 Fed. Reg. 20,590.

9. Implementation of U.K. and Australian Cooperation Treaties. In November 2011, DDTC proposed a series of new rules to implement two different defense cooperation treaties signed in 2007 between the U.S. and the United Kingdom and between the U.S. and Australia. See 76 Fed. Reg. 72,246. While these treaties were originally signed nearly five years ago, they were only recently ratified by the Senate in September 2010. While the proposed rules at ITAR §§ 126.16 and 126.17 are not as expansive as the Canadian exemptions at ITAR § 126.5, the proposed rules represent the first step in a more streamlined process for sharing defense articles and technical data with our U.K. and Australian allies.

10. Proposed Updates to ITAR Brokering Requirements. In December 2011, DDTC proposed new rules to clarify restrictions on brokering activities, including clarifications relating to registration requirements and the scope of brokering activities, as well as the types of activities that require prior approval from DDTC. See 76 Fed. Reg. 78,578.

Conclusion

These new and proposed changes have been put forward with an eye toward improving the administration of the U.S. export requirements and reducing the licensing burden for U.S.-origin products and technologies. These changes attempt to advance the four key goals of the administration's export reform agenda:

A. Creation of a single list of controlled items and technologies, replacing the two lists currently in place – the USML and CCL. The proposed creation of the new "Commerce Munitions List" under the CCL is an intermediate step to the dream of a final, single control list.

B. Consolidation of export licensing in a single agency, replacing the numerous agencies that currently authorize licenses, including DDTC, BIS and the Office of Foreign Assets Control (among others).

C. Consolidation of export enforcement in a single agency, replacing the numerous agencies that currently enforce the export and sanction restrictions.

D. Use of a single IT system to submit and process license applications, replacing the different systems used by each of the different agencies. In 2011, the U.S. State Department announced the expanded use of an upgraded USXPORTS system (previously used only by the Department of Defense), which many hope will provide an eventual government-wide IT solution. While exporters will still submit licenses through separate portals (such as SNAP-R, DTrade, or ELLIE), it is hoped that use of USXPORTS will streamline the intra-governmental coordination on licensing.

In order to reach these laudable goals, many more changes will still be required. Some reforms will require new legislation, and others will require political compromises as one agency cedes authority to another. Regardless, thus far the government has made good on its promise to involve industry in the reforms, and the developments in 2011 are a positive sign that the promised improvements may actually occur. It may not be happening as quickly as many in industry and the government would like, but slow, forward motion like that seen throughout 2011 is clearly much better than no motion at all.

Authored by:

David S. Gallacher
(202) 218-0033
dgallacher@sheppardmullin.com

FAPIIS: Update on Government FAPIIS Postings: Quick Contractor Reaction Required

Sheppard Mullin — Wed, 11 Jan 2012 11:50:22 -0800

By: W. Bruce Shirk

Our previous discussions of the Federal Performance and Integrity Information System (“FAPIIS”) posted here in June 2010 and March 2011, urged contractors generally to manage affirmatively FAPIIS and, specifically, to: (i) place a high priority on entry and updating of data into FAPIIS; (ii) take advantage of every opportunity to comment on, explain or rebut information posted in FAPIIS; and (iii) be alert for Government posting of harmful information, in particular information potentially protected from disclosure by a Freedom of Information Act ("FOIA") disclosure exemption, Exemption 4. It is now apparent that, in light of a recent action of the Civilian Agency Acquisition Council and the Defense Acquisition Regulation Council (“the Councils”), contractors who successfully manage FAPIIS will be those contractors who not only implement the above steps but do so very quickly and are, as well, hyperalert for and prepared to react immediately to Government posting of potentially harmful information.

On January 3, 2012, the Councils finalized the rule initially proposed on January 24, 2011 amending FAR sections 9.104-7, 9.105-2, 9.406-3, 42.1503 and the clause at FAR 52.209-9 to implement the requirement of Section 3010 of the Supplemental Appropriations Act, 2010. That Act requires that the information in FAPIIS, “excluding past performance reviews, . . . be made publicly available.” Public Access to the Federal Awardee Performance and Integrity Information System, 77 Fed. Reg. 197 (Jan. 3, 2012). As to the final rule, the Councils note that FAPIIS consists of two segments, a non-public segment," also known as the Past Performance Information System (PPIRS), and a publicly available segment, also known as the “public site.” The Councils also noted that “the structure of FAPIIS ensures that 'past performance reviews' will not be inadvertently released . . .” because such information is stored in the PPIRS module, which is “completely separate . . . from the other [publicly available] information in FAPIIS.” 77 Fed. Reg. 199. The Councils’ assurance of “complete” separation, while probably not literally inaccurate, is nevertheless confusing because, as it turns out, government-generated information intended for ultimate posting on the public site is first entered into FAPIIS via the non-public segment – and it is at this point that the importance of a very high level of contractor alertness becomes apparent. Here's why.

Our March 2011 discussion noted that government-generated information destined to be posted on the public site includes contracting officer final determinations of:

contractor default,
submission of defective cost or pricing data,
non-responsibility, and
suspension and debarment official listing of a contractor in the Excluded Parties Listing System (“EPLS”) and related matters, (e.g., contractor execution of an Administrative Agreement). FAR 9.105-2(b)(2); 77 Fed. Reg. 199.

These determinations regarding contractor integrity, any of which can contain potentially harmful contractor proprietary information or other commercial sensitive information protected from disclosure exemption under FOIA, are to be posted to FAPIIS' non-public segment within three working days of finalization of the determination by the responsible government official. The official must also give immediate notice of the posting to the contractor who then has a mere seven calendar—not working—days to: (i) review the posted information, and (ii) assert in writing to the official that information has been posted that is covered by a disclosure exemption under FOIA and, citing FAR 52.209-9, explicitly request its removal from the site. The government official must then within seven calendar days remove the posting from the non-public FAPIIS segment and “resolve the issue in accordance with agency” FOIA procedures prior to re-posting any of the information determined to be releasable. FAR 9.105-2 (b)(2). Ominously, “[i]f the Government official does not remove the item, it will be automatically released to the public site within 14 calendar days after the review period began.” 77 Fed. Reg. 196; FAR 52.209-9(b)(2) (emphasis added).

Seven days is, on its face, a very brief period of time for a federal contractor to review, analyze, and respond in writing to a final determination posting that discloses proprietary or other commercial sensitive information covered by a FOIA exemption. Recognizing this fact, several individuals who submitted comments on the regulation as initially proposed urged that the Councils adopt response periods ranging from 30 to 60 days for contractors to review such information and prepare a response. But the Councils, nevertheless, have specified seven days and contractors must accept and deal with the brevity of the period available to respond to posting of final determinations and EPLS listings. But the brevity of this particular review period perhaps holds a larger lesson, which is that the government is announcing its intention that FAPIIS operate efficiently and at high speed. Thus, while the regulations provide a somewhat longer—albeit still very brief—period of 30 days to respond to past performance information in PPIRS. The regulations place no time limit on the contractor opportunity to post comments rebutting government-generated information posted to the FAPIIS public site, probably because it is viewed as unnecessary. After all, contractors have a clear incentive to react quickly to such postings because the longer damaging information is available on the public site without contractor explanation the more harm it is likely to cause. In any event, this recently issued final rule highlights the reality that potentially damaging government-generated information can now appear on short notice in FAPIIS, whether in PPIRS or the public site. Contractors ignore this reality at their own risk.

Authored by:

W. Bruce Shirk
(202) 741-8426
bshirk@sheppardmullin.com

"Bah! Humbug!" - 3% Withholding and the Ghost of Christmas Future

Sheppard Mullin — Wed, 11 Jan 2012 11:38:36 -0800

By: David S. Gallacher

Just in time for the end-of-year push to fund the Government and to "create more jobs," members of Congress and President Obama had a rare moment of consensus when they unanimously(!) repealed an extremely unpopular withholding requirement that has been haunting recipients of federal funds since 2005. The "3% Withholding Repeal and Job Creation Act" was signed into law on November 21, 2011 (Pub. L. No. 112-56, Title I), eliminating a requirement to withhold 3% on most payments to contractors and grant recipients. While there are many in Government and industry alike who are ecstatic at the passage of the Act, the Ghost of Christmas Future warns that this specter of "withholding" may not have yet fled the scene. Like poor, chained Jacob Marley from Dickens' A Christmas Carol, industry may yet find itself captive, bound, and double-ironed by future Congressional plots to confiscate funds from government contractors. Miserly grasping for every penny, one can almost hear the federal Government grumbling, "Bah! Humbug!"

The Ghost of Christmas Past – Background on the 3% Withholding

The 3% withholding requirement dates back to 2005 and the Tax Increase Prevention and Reconciliation Act (Pub. L. No. 109-222), which, among other things, extended the "Bush Tax Cuts" on capital gains and dividends, while simultaneously attempting to identify additional sources of revenue. Recognizing that some companies receiving federal contracts or grants were also delinquent in paying their income taxes, Congress decided that withholding 3% from payments to most contractors and grant recipients would help to improve the recovery of delinquent taxes. See Pub. L. No. 109-222,§ 511. Committed to avoiding the day of reckoning, however, Congress delayed the start of the withholding requirement for another 5 years – until December 31, 2010. Notably, there was little discussion as to the wisdom or feasibility of implementing the withholding requirement; instead, Congress simply passed the 3% withholding as one of several "revenue offset provisions."

Almost from the beginning, everyone recognized that the withholding requirement would, at best, generate only modest revenues and that the withholding requirement also presented significant drawbacks. DOD estimated that the $17 Billion cost of implementing the requirement over five years would exceed any anticipated revenue gains from the same period. Industry argued that the withholding did little more than restrict a company's cash flow while simultaneously imposing pointless administrative burdens. While the withholding would be used to supplement annual income tax payments, fully-compliant contractors would be entitled to full repayment of the 3% at the end of the year with little net benefit for the government. In fact, the very day that the Act was signed into law, legislation was introduced to repeal the withholding requirement. See S. 2821, 109th Congress (May 17, 2006). Later, as part of the Stimulus Act in 2009 (Pub. L. No. 111-5, Division B, Section 1511), the withholding requirement was delayed until December 31, 2011, and the Internal Revenue Service' final regulations implementing the law further delayed the full implementation until December 31, 2013. See 76 Fed. Reg. 26,583, 26,678.

Needless to say, the haunting presence of this withholding requirement generated a fair bit of anxiety among recipients of federal funds. In fact, we have frequently been asked to speak on this topic, and slides from one of our recent seminars in the Summer of 2011 can be viewed by clicking here.

The Ghost of Christmas Present – The Recent Repeal

Driven in part by the efforts of industry groups like the Government Withholding Relief Coalition, the push to repeal the withholding requirement gained significant steam in 2011. With virtually everyone in Government and industry alike opposing it, the key factor that prevented its repeal was indentifying spending cuts to offset the loss of revenue that would come from eliminating the withholding. Not surprisingly, since the biggest news stories of 2011 have revolved around "government spending" and "budget cuts," the repeal effort struggled to gain any real momentum. However, when the 3% withholding repeal was paired with another bill to provide tax incentives and employment benefits for U.S. veterans (which was part of President Obama's original jobs bill that failed in the Senate), the opponents of the withholding finally achieved victory.

The Ghost of Christmas Future – Congressional Demands to Investigate Future Revenue Streams

Eclipsed by the celebration accompanying the repeal of the 3% withholding requirement, Public Law No. 112-56 also directed the Department of the Treasury to investigate additional ways by which the government can reduce the amount of delinquent taxes owed by federal contractors. See Title III, Section 302. Notably, this provision does not attempt to investigate recovery against "grant recipients," which receive approximately half of all federal discretionary spending. Instead, Congress has focused on the Government's favorite stalking horse – the nefarious and treacherous "government contractor," which many in Congress and the media would have us believe are responsible for all of the government's ills.

Essentially, the purposes of the Section 302 report are to identify: (1) ways by which the government can better identify government contractors and subcontractors that owe delinquent taxes; and (2) recommendations, including legislative changes, on how the government can better recover those delinquent taxes from the contractor. Faced with such scrutiny, and finding itself in dire need for funding, it seems likely that Congress will come up with other ways by which it can extract additional revenue from the government contractors.

While the 3% withholding requirement proved to be a blunt tool that would not have effectively resolved the delinquent tax issue, the Government has repeatedly demonstrated its preference for using blunt – as opposed to precise – solutions. Blunt tools require less consensus; they are easier to draft; they are (ostensibly) easier to implement. Congress has demanded a report from the Department of the Treasury by November 2012 to identify ways in which contractor tax delinquency can be addressed. Do not be surprised if Treasury identifies a number of solutions that are as overly broad and dysfunctional as the 3% withhold. Congress' change of heart on the withholding issue in 2011, should give industry absolutely no assurances that Congress cannot (or will not) again be persuaded by equally bad ideas based on unrealistically rosy revenue projections similar to those made back in 2005 when withholding was originally adopted. "Bah! Humbug!"

Authored by:

David S. Gallacher
(202) 218-0033
dgallacher@sheppardmullin.com

Upcoming Speaking Engagements

Sheppard Mullin — Wed, 11 Jan 2012 11:00:19 -0800

Keith Szeliga

"New Government Contractor Rules on Personal Conflicts of Interest and Revolving Door Restrictions: Implementing Internal Controls to Comply With FAR PCI Requirements and DoD Post-Employment Restrictions."

CLE Webinar/Teleconference

Wednesday, February 1, 2012, 1pm – 2:30pm, EST

http://www.straffordpub.com/products/new-government-contractor-rules-on-personal-conflicts-of-interest-and-revolving-door-restrictions-2012-02-01

--------------------------------------------------------------------------------

W. Bruce Shirk

"Hot Topics in Government Contracting"

Medicare Executives Conference, Blue Cross and Blue Shield Association

Wednesday, January 25, 2012, 1:30pm, Hyatt Regency Baltimore Inner Harbor, Baltimore, MD

http://www.governmentcontractslawblog.com/uploads/file/GBS Meeting 012512

Protests Rise; Winners Fall: GAO Releases Its Latest Protest Statistics

Sheppard Mullin — Fri, 09 Dec 2011 13:06:43 -0800

By: Anne Perry

While the number of protests has steadily increased over the past five years, the success rate for protesters in Fiscal Year 2011 was at its lowest during that time. GAO reported to Congress its Bid Protest Statistics for Fiscal Year 2011 on November 15, 2011 and it reflects a bit of a tougher year for protesters but no real significant changes from last year.

There were 2,353 protests filed in 2011, including 144 cost claims and requests for reconsideration, but GAO sustained only 67 protests, a mere 16 percent. This compares to 2,226 filed cases and a 19 percent sustain rate in 2010. Moreover, it is a huge departure from the 27 percent sustain rate in 2007. GAO reported that the "effectiveness rate," which GAO defines as instances where a protester obtains "some form of relief from the agency, as reported to GAO," remained constant from last year at 42 percent. On the bright side, however, while fewer protesters were successful, all federal agencies reported that they fully implemented the GAO recommendations in those sustained protests.

GAO closed 2,292 cases but issued only 417 "merit (sustain + deny)" decisions, about 10 percent less than last year, despite the 2 percent increase in the total number of filed protests. The rest of the closed cases were disposed of, for example, through dismissals for procedural errors, withdrawals by protesters, or Alternative Dispute Resolutions ("ADR"). Down 2 percent from 2010 was the number of hearings held; 46 cases versus 61 in 2010; thus they were held in just 8 percent of the cases filed versus 10 percent in 2010. ADR was also down, having been used in only 140 cases, down from 159 in 2010. The ADR success rate, however, was up 2 percent to 82 percent. So fewer instances of ADR, but GAO was more successful in obtaining resolution.

Years ago, those arguing against GAO jurisdiction over task order protests prophesied paralyzing numbers of protests would materialize. The numbers, however, do not bear that out – GAO received only 147 such protests in 2011. This is hardly a significant number given the multitude of very large multiple award IDIQ contracts and enormous task orders awarded thereunder.

Overall, no huge surprises emerge from GAO's statistics, although the trends are, in some respects, headed in the wrong direction for protesters. Then again, maybe the agencies are getting better at buying? The complete GAO report to Congress can be found here.

Authored by:

Anne Perry
(202) 218-6875
aperry@sheppardmullin.com

A New Twist On Establishing Interested Party Status At The GAO

Sheppard Mullin — Fri, 09 Dec 2011 13:01:50 -0800

By: Townsend Bourne

In a bid protest decision regarding the propriety of agency corrective action, GAO recently carved out a new exception to its general rule that those who do not participate in a protest that engenders corrective action are not interested parties to challenge the corrective action. In North Wind, Inc.; Earth Resources Technology, Inc., B-404880.4 et al., 2011 CPD ¶ 246 (Comp. Gen. Nov. 4, 2011), North Wind, Inc. (“North Wind”) protested NASA’s initial award of a contract to Navarro Research and Engineering, Inc. (“Navarro”) and subsequently raised additional challenges to the award in a supplemental protest that followed receipt of documents from the Agency. In response to North Wind’s supplemental protest, NASA decided to take corrective action. Earth Resources Technology, Inc. (“ERT”), another disappointed offeror in the competition, did not initially file its own protest challenging the award to Navarro.

Following reevaluation of proposals by NASA and a subsequent award again to Navarro, North Wind again protested the award decision. This time, however, ERT also filed a protest challenging the Agency’s reevaluation and decision to award the contract to Navarro. Both NASA and Navarro challenged ERT’s status as an interested party, citing the general rule that an offeror that failed to participate in the original protest is not eligible to protest corrective action taken by an agency in response to the original protest. See Formal Mgmt. Sys., B-260412, B-260412.3, 95-2 CPD ¶ 158 (Comp. Gen. Oct 4, 1995). However, GAO quickly dismissed this argument, stating that ERT’s protest was a protest of “the ultimate selection decision that resulted from the earlier corrective action” rather than a protest of the corrective action itself. This subtle distinction, held GAO, rendered ERT an interested party.

Thus, challenging an award decision following agency corrective action without taking part in the original protest is now clearly a viable option. Of course, the exception is fairly narrowly drawn and, if the challenge focuses on the scope of the corrective action versus its outcome, the non-protesting party must still forever remain silent.

Authored by:

Townsend Bourne
(202) 469-4917
tbourne@sheppardmullin.com

DOD Issues New Guidance on B&P - But Is It Right?

Sheppard Mullin — Fri, 09 Dec 2011 12:58:56 -0800

By: John W. Chierichella

CAS 402 has long provided that B&P costs incurred pursuant to a specific requirement of an existing contract may be distinguished from B&P generally and treated as direct costs of the requiring contract. As CAS 402-61 states:

The circumstances are different because the costs of preparing proposals specifically required by the provisions of an existing contract relate only to that contract while other proposal costs relate to all work of the contractor.

Given this long-established prescription, the November 10, 2011 memorandum issued by the Office of the Under Secretary of Defense entitled “Direct and Indirect Charging of Contractor Proposal Preparation and Negotiation Support Costs” is, in some ways at least, unremarkable. It hardly breaks new ground for the DOD to state, for example, that:

Proposal and negotiation costs should only be charged directly to a contract when there is a specific contractual requirement for the contractor to submit a proposal.

Nor, given the emphasis in CAS 402 on the need for a “specific” contract requirement to support the direct costing proposal preparation costs, is it surprising that the November 10th memorandum states that:

For the costs to be charged directly to a contract there must be a specific requirement in an existing contract to submit that particular proposal, not just an implied requirement.

Nonetheless, there are some new and troubling aspects to the DOD guidance.

First, the memorandum states that the “specific requirement” that supports direct charging “should manifest itself in the contract, such as in a funded line item.” The first half of that sentence is a truism, because if it does not manifest itself in the contract then the requirement is not “specific,” but implied, and outside the reach of the CAS 402-61 Interpretation that supports direct charging of proposal costs. But the second half of the sentence finds no expression or support in CAS 402 or FAR 31.205-18 and represents an effort at unilateral rulemaking that is beyond the realm of the Secretariat’s authority. One can now envision squads of auditors disallowing proposal costs associated with specific contract requirements on the ostensible ground that there is no “funded line item” for the proposal. It will be unfortunate if contractors now find themselves fighting for the recovery of the costs incurred under the specific requirements of the Changes Clause, the Value Engineering Clause, or clauses requiring the submission of proposals to definitize unpriced contract actions because auditors or contracting officers believe that a “funded line item” is a condition precedent to direct charging of proposal preparation effort.

Second, to avoid paying the fair and reasonable costs of proposals specifically required by existing contracts, the memorandum suggests that contracting officers place cost controls on the proposal effort, in the form of firm fixed or not-to-exceed prices, using the “typical B&P costs” incurred by contractors and allocated as indirect costs. The memorandum announces the imminence of a new DFARS rule to gauge the adequacy of contractor proposals and we await with great interest the manner in which – if at all – that DFARS rule addresses the definition of “typical B&P costs” and the “typical” requirements against which those B&P costs were generated.

Third, the memorandum is simply wrong when it states that:

If there is a specific requirement in an existing contract to submit one or more proposals, cost of preparing those proposals are allocable only to the contract requiring the proposal submission.

This assertion misreads CAS 402-61. The Standard allows proposal costs to be charged directly to a contract under certain circumstances. It does not compel that accounting treatment. CAS 402-61(d) specifically states that:

This interpretation does not preclude the allocation, as indirect costs, of costs incurred in preparing all proposals. The cost accounting practices used by the contractor, however, must be followed consistently and the method used to allocate such costs, of course, must provide an equitable distribution to all final cost objectives.

Few contractors, in our experience, adopt this alternative, but it is – here’s that word – a “specific” and authorized alternative method of accounting for B&P. OUSD does not get to repeal CAS 402-61(d) through the simple expedient of issuing a unilateral memorandum. Perhaps a revised memorandum will be forthcoming . . . but I doubt it.

Authored by:

John W. Chierichella
(202) 218-6878
jchierichella@sheppardmullin.com

Aiming for a Moving Target: Bad and Good News on Changing Iran Sanctions

Sheppard Mullin — Fri, 09 Dec 2011 12:15:44 -0800

By: Scott Maberry and Reid Whitten

On November 21, 2011, President Barack Obama signed Executive Order 13590 expanding sanctions against non-U.S. companies doing business in Iran. Under the new rules, whole sectors of business between Iran and third countries are now subject to U.S. sanctions. Overnight, non-U.S. companies working in Iran—in sectors not previously subject to sanctions—found their contracts subject to punishment under U.S. law. Many of these companies had invested significant resources in making sure their transactions in Iran did not fall afoul of U.S. sanctions, some having met directly with U.S. Government agencies, including the U.S. State Department, to understand the rules. These companies must now again adjust the aim of their compliance efforts to hit moving targets.

Fortunately for these companies, it appears likely that in the near-term, contracts already in place and compliant with the rules at the time of the November 21 order will not be the target of enforcement actions.

Background

On July 1, 2010, the Comprehensive Iran Sanctions, Accountability, and Divestment Act (CISADA) was signed into law. In August 2010, the U.S. Treasury Department Office of Foreign Assets Control (OFAC) implemented CISADA through regulations under which the U.S. government could impose a range of penalties against companies doing more than $20 million of business in a year (or any one-time transaction of more than $5 million) with the Iranian petroleum industry.

U.S. persons, including U.S. companies, were already generally prohibited by OFAC sanctions from doing business in Iran, so the effect of the CISADA sanctions fell mainly on non-U.S. companies that conducted business in or with Iran.

Changes Under the New Executive Order

The November 21, 2011 Executive Order substantially expands the types of transactions subject to sanction. Specifically, the new rules create two major changes to the measures enacted under CISADA:

1. With respect to a transaction that "could directly and significantly contribute to the maintenance or enhancement of Iran's ability to develop petroleum resources in Iran," the threshold level for sanctionable transactions is reduced from $20 million in a one-year period (the level set in the CISADA) to $5 million in a one-year period. In addition, any single such transaction that has a fair market value of $1 million or more will now expose the transaction party to sanction.

2. With respect to a transaction that "could directly and significantly contribute to the maintenance or expansion of Iran's domestic production of petrochemical products" (a sector not previously subject to CISADA sanctions), sanctions may be imposed for transactions that amount to $1 million or more in fair market value during a one-year period. Furthermore, any single such transaction that has a fair market value of $250,000 or more will expose the transaction party to sanction.

The ratcheting up of sanctions reflects an increasing push by the U.S. Government (and, increasingly, many U.S. trading partners) to increase leverage against Iran's nuclear development programs.

Compliance With Changing Requirements

The spasmodic expansions of Iran sanctions may give the impression of traps laid to snare businesses by suddenly prohibiting various types of transactions. But the U.S. State Department has said it does not intend to play “gotcha” games with companies that do business in or with the United States, and that the real target of the sanctions is the government of Iran.

Based on recent experience under CISADA, we do not believe that the State Department will prioritize sanctions against companies with contracts that were compliant when executed but became prohibited by the new Executive Order, at least in the near term. Conversely, we believe that sanctions will be imposed against companies that initiate new contracts or expand existing contracts to provide goods or services to the Iranian petroleum and petrochemical industries. We also believe that the State Department will publish guidance on compliance with these new rules shortly. We anticipate that this new guidance will outline State's policy toward deliveries against existing contracts.

Looking Ahead – Upcoming Changes to Iran Sanctions

Businesses engaged in compliant activities in or related to Iran should be aware that, while they may now be standing safely on the shore, the tide may still be moving in: such companies face the risk that their currently-allowable transactions may, in the near future, become subject to new sanctions. At the time of this article’s publication, two bills are under consideration in the U.S. House of Representatives that propose to further increase measures by the U.S. Government against Iran. H.R. 3439[1] proposes extending CISADA measures to businesses transacting with the Central Bank of Iran in certain cases, while H.R. 1905[2] proposes prohibiting communication by any U.S. Government personnel with anyone “affiliated” with the government of Iran. In addition, on December 1, 2011, the U.S. Senate passed an amendment to a defense bill that would specifically disallow organizations that do business with financial institutions in Iran, including Iran’s central bank, from holding financial accounts in the United States. It is unclear what chances these pieces of legislation have of becoming law, but they illustrate the same lesson: the boundaries of what is allowed with respect to Iran will likely continue to change.

A company aiming to remain compliant with U.S. laws and regulations is at the greatest advantage when it carefully tracks the shifts in regulations and directs its compliance efforts ahead of the moving target. We will continue to keep a weather eye on Iran sanctions, and report significant developments as they occur.

Authored by:

Scott Maberry
(202) 469-4975
smaberry@sheppardmullin.com

and

Reid Whitten
(202) 469-4978
rwhitten@sheppardmullin.com

[1] Titled: To require the President to impose sanctions on foreign financial institutions that conduct transactions with the Central Bank of Iran if the President determines that the Central Bank of Iran has engaged in certain transactions relating to the proliferation of chemical, biological or nuclear weapons or support for acts of international terrorism

[2] Titled: The Iran Threat Reduction Act of 2011

Clarity Required: Iran Sanctions Convictions Reversed in U.S. v. Banki

Sheppard Mullin — Fri, 09 Dec 2011 11:51:24 -0800

By: Thad McBride and Mark L. Jensen

Introduction: On October 24, 2011, a three-judge panel of the U.S. Court of Appeals for the Second Circuit released an opinion in United States v. Banki, No. 10-3381 (2d Cir. Oct. 24, 2011) that reversed convictions of Defendant Mahmoud Reza Banki on charges of conspiring to violate the Iranian Transaction Regulations (“ITR”) and aiding and abetting violations of the ITR.[1] In doing so, the Court contradicted the position of the U.S. Government in a manner that may have important consequences for how the Government pursues sanctions enforcement matters going forward.

Background. With limited exceptions, the ITR prohibit most economic transfers between the United States and Iran, including exports of U.S. origin goods, technology, or services from the United States or U.S. persons to Iran. See 31 C.F.R. § 560.204. The ITR portion of the Iran sanctions have been in place since 1995, though the United States has periodically ratcheted up sanctions on Iran since that time, most recently in November 2011, as explained in this month's blog article "Aiming for a Moving Target: Bad and Good News on Changing Iran Sanctions."

According to the opinion, Banki is an Iranian-born, naturalized U.S. citizen with family in Iran. Starting in May 2006, family members in Iran transferred $3.4 million to Banki for personal use in the United States through the “hawala” system, a network of money brokers that is widely used to make international funds transfers in Middle Eastern and South Asian countries. As described by the Court, hawala brokers act as international economic go-betweens without ever making direct financial transactions across country boundaries. Banki, No. 10-3381, at 4-5. For example, for a transfer from Iran to the United States, a hawala broker in Iran would receive payment from an individual in Iran, then contact a broker in the United States who would pay the U.S. recipient.

To carry out these types of transactions, Banki’s hawala broker based in Iran would search across a wide network of his U.S. contacts, none of whom Banki knew, for a matching amount of money moving from the United States to Iran at the same time the transfer from Banki’s family was made to Banki. As a result, Banki received several deposits in his U.S. bank account as a result of monetary transfers involving a wide range of individuals and companies. Banki typically e-mailed a family member to confirm receipt of funds in his Iranian account; some of which, according to the Court, indicated that Banki knew money was moving from the United States to Iran related to his hawala transactions. Based on these facts, Banki was convicted of violating the prohibition in the ITR against exporting services to Iran, 31 C.F.R. § 560.204, and was sentenced to 30 months in prison. Banki, No. 10-3381, at 10, 12.

The Opinion. After first dismissing Banki’s argument that money transfers to Iran qualified as “services” under the ITR only if undertaken for a fee, the Court overturned his convictions related to the ITR on his second argument, that the district court erred by failing to instruct the jury that non-commercial remittances to Iran are exempt from the ban on export of services under 31 C.F.R. § 560.204.

In so ruling, the Court relied on 31 C.F.R. § 560.516, which provides that “U.S. depository institutions are authorized to process transfers of funds to or from Iran” in certain circumstances, including where “[t]he transfer arises from an underlying transaction that is not prohibited by this part, such as a non-commercial remittance to or from Iran.” Banki argued that this provision specifically permitted a non-commercial remittance to or from Iran, including a “family remittance.” The government, by contrast, argued that such remittances would be allowed only if processed through a U.S. depository institution. While the Court demurred as to the precise meaning of the regulation, it held that “at a minimum, the regulation is ambiguous in this respect.” Banki, No. 10-3381, at 20. Citing the U.S. Supreme Court decision U.S. v. Santos, 553 U.S. 507 (2008), the Court held that it was required to interpret the ambiguous regulation in favor of Banki as a criminal defendant. Id. at 20-21.

Analysis. We think the key takeaway from Banki is how the Court dealt with what it perceived (and many exporters would agree) as the ambiguity of the ITR. The Court makes much of this ambiguity, and, at base, the holding suggests that the U.S. Department of Treasury, Office of Foreign Assets Control (“OFAC”) may have a high hurdle to demonstrate that its view of the regulations comports with the plain text of the regulations where criminal convictions are sought. The Court’s analysis of the ITR is quite literal, as one might expect given that U.S. federal courts are rarely called upon to interpret OFAC’s regulations. That view of the regulations could significantly affect U.S. sanctions enforcement precisely because many of the U.S. sanctions are relatively ambiguous on their face, even where OFAC may have an established view of their meaning to the point that outside counsel and industry have accepted that view.

A few provisions might be particularly limited by a literal reading. First, criminal prosecutions of the “facilitation” provisions of the ITR, 31 C.F.R. §§ 560.208; 560.417, prohibiting U.S. persons from approving, financing, facilitating, or guaranteeing a transaction by a foreign person that would be prohibited if performed by a U.S. person, could be significantly constrained by this interpretive limitation. Secondly, criminal applications of the “evading or avoiding” provisions found in many U.S. sanctions could potentially be significantly constrained if only allowed in circumstances where their application is not ambiguous. See, e.g., 31. C.F.R. § 560.203.

Of course, the impact of this aspect of Banki is limited somewhat by its application in the criminal context. For most OFAC enforcement activity, which occurs in a non-criminal context, the rule of lenity enumerated in Banki may not be particularly helpful to a defendant making its case against, for example, a civil fine. Even in those circumstances, however, the fact that the Court found specific provisions of the ITR to be ambiguous where the Government argued for a fixed meaning may embolden parties facing civil fines to press their own interpretation of the regulations.

Conclusion. Although Banki involved a relatively sophisticated fact pattern and a relatively narrow focus on the question of family remittances, its holding dismissing criminal charges based on the ambiguity of the criminal regulations has potentially wide-ranging effects. While the ambiguity of U.S. sanctions regulations may at times seem to broaden their scope and application to persons seeking to comply with the laws, in this instance the Court inverted that presumption by forcing the burden of clarity onto the Government.

It seems somewhat unlikely that OFAC will seek to clarify otherwise ambiguous provisions of the regulations based on one holding, but the opinion does provide at least qualified comfort to persons dealing with relatively ambiguous regulations. We will be interested to see any broader impact of the holding on future or existing enforcement measures.

Authored by:

Thad McBride
(202) 469-4976
tmcbride@sheppardmullin.com

and

Mark L. Jensen
(202) 469-4979
mjensen@sheppardmullin.com

[1] Banki was also convicted on charges of making materially false representations in response to a government subpoena, which were affirmed by the Second Circuit, and on charges of conspiring to operate an unlicensed money-transmitting business and aiding and abetting in an unlicensed money-transmitting business, which were vacated and remanded by the Second Circuit.

Court of Federal Claims Reaffirms Exceptions To The Anti-Assignment Act

Sheppard Mullin — Fri, 09 Dec 2011 11:37:53 -0800

By: Marko W. Kipa

The United States Court of Federal Claims recently reaffirmed the applicability of two exceptions to the Anti-Assignment Act (the “Act”). Liberty Ammunition, Inc. v. United States, 2011 WL 5150221 (Fed. Cl. Oct. 31, 2011). Specifically, the Court acknowledged that (1) the Government may prospectively waive the Act, and (2) the Act does not prohibit the transfer of an agreement where the transfer occurs by operation of law. Id. at *6-8. Notably, the Court’s decision provides further guidance for contractors undertaking corporate reorganizations and/or examining whether a particular acquisition transaction requires the execution of a novation agreement. We previously discussed the novation requirements here.

In Liberty Ammunition, the plaintiff argued, in pertinent part, that the Government infringed upon its patent for an environmentally friendly bullet and violated several non-disclosure agreements (“NDAs” or “Agreements”). Id. at *1. The NDAs in question contained the following anti-assignment provision:

Neither party may sell, transfer, or assign this Agreement except to entities completely controlling or controlled by that Party or to entities acquiring all or substantially all of its assets, without the prior consent of the other.

Id. at *2. The plaintiff’s company had undergone a series of transformations/reorganizations since the time the plaintiff initially entered into the NDAs. Id. The Government moved to dismiss the plaintiff’s Complaint, in part, because it alleged that the Act barred the transfer of the Agreements. Id. at *4. As such, the Government argued, the plaintiff lacked privity of contract with the Government, which deprived the Court of subject matter jurisdiction. Id.

The Court denied the Government’s motion to dismiss because the plaintiff presented a prima facie case that it may qualify for two exceptions to the Act. Id. at *6.

First, the Court explained that the Government may waive the Act’s proscriptions. Id. The Court relied on the anti-assignment provision in the NDAs allowing for sale, transfer or assignment without the counterparty’s consent in certain circumstances. Id. The Court rejected the Government’s position that the Act may be waived only “after the fact.” Id. After analyzing the applicable case law, the Court concluded that the Government may prospectively waive the requirements of the Act. Id. at *6-7.

Second, the Court relied on another exception to the Anti-Assignment Act – i.e., where the transfer occurs “by operation of law.” Id. at *7. The plaintiff in Liberty Ammunition alleged that the transfers did not require Government consent since the transactions at issue involved all of the Company’s assets or were the result of corporate reorganizations. Id. The Court noted that, in certain acquisition transactions, “the contract with the [g]overnment continues with essentially the same entity, which has undergone a change in its corporate form or ownership.” Id. (quoting L-3 Commc’ns Integrated Sys., L.P. v. United States, 84 Fed. Cl. 768, 777 (2008)). The Court, thus, concluded that these allegations were sufficient to defeat the Government’s motion to dismiss. Id.

While these counts survived the Government’s motion to dismiss, it remains to be seen whether the plaintiff can meet its burden of proof on the merits. Id. at *8. Nevertheless, the Court’s holding reaffirms the validity of two exceptions to the Act and is consistent with the principle that the Government may waive the Act’s proscriptions since the Act is intended to benefit the Government. It also may prove useful for contractors undertaking a corporate reorganization and/or determining whether a novation agreement is required in connection with a particular acquisition transaction. However, as we have said before, a contractor’s best bet is to engage the Contracting Officer early in the process and to get his/her opinion about whether a novation agreement is required. After all, an executed novation agreement provides the contractor with the Government’s “stamp of approval” for the transfer in the event a question should arise further down the road.

Authored by:

Marko W. Kipa
(202) 772-5302
mkipa@sheppardmullin.com

New Disclosure Requirements For Companies Doing Business In California

Sheppard Mullin — Fri, 09 Dec 2011 10:57:04 -0800

By: John W. Chierichella

In our February 2009 posting, we commented on the final rule implementing, via FAR 52.222-50 (“Combating Trafficking in Persons”), the Trafficking Victims Protection Reauthorization Act of 2005.

On January 1, 2012, companies doing business in California will have state-level disclosure obligations to deal with in this realm as well. That is the effective date of the California Transparency in Supply Chains Act of 2010, which imposes obligations on every large retailer and manufacturer doing business in California to disclose whether it has taken specified actions to eliminate slavery and human trafficking from its product supply chain.

For a comprehensive analysis of the California statute, its applicability to companies that are neither organized nor domiciled in California, the disclosure obligations it imposes, remedies, how companies can and should respond to the statute, and the public relations implications of a minimalist approach to compliance, click here to link to an article recently authored by Peter Menard of Sheppard Mullin’s Los Angeles office and published in the California State Bar’s “Business Law News.” If you have questions in this area, Peter can be reached directly at pmenard@sheppardmullin.com or at (213) 617-5483.

Authored by:

John W. Chierichella
(202) 218-6878
jchierichella@sheppardmullin.com

Using the Internet to Defend Against a Whistleblower Action

Sheppard Mullin — Fri, 09 Dec 2011 10:52:20 -0800

By: Anne Perry

We often cover social media aspects pertinent to government contracting here on the blog. Recently, however, Michelle Sherman of Sheppard Mullin’s Los Angeles office posted an article that may be relevant to contractors on the Social Media Law Update blog. In her posting, Michelle discusses how companies may be able to use the widespread and immediate dissemination of corporate news online to defeat the “original source” prong of a whistleblower action. For a comprehensive analysis of the issue, please click here.

If you have any questions, Michelle can be reached at msherman@sheppardmullin.com or (213) 617-5405.

Lunch With Your Government Contracts Lawyers

Sheppard Mullin — Fri, 09 Dec 2011 09:00:09 -0800

Sheppard Mullin will be launching in 2012 a series of luncheon seminars to be held at its offices in Washington, D.C. and Los Angeles, California, on topics of ongoing (and increasing) importance to Government contractors. These seminars will provide the opportunity for attendees to receive an informed 90-minute presentation on relevant legal issues, and the opportunity for interactive dialogue with our lawyers and MCLE credit, all in the informal setting of a lunch in Sheppard Mullin’s offices.

The specific schedule for the seminars will be posted at a later date. We plan, however, to host seven seminars, on the following topics:

"Anatomy of a Bid Protest"
"Government Contracting in Budget-Challenged Times -- Special Concerns for the Government Contractor When Dollars Become Scarce"
"Organizational Conflicts of Interest -- What Are They, Where Have We Been, and Where Are the New Regulations Taking You?"
"So You Just Received a Subpoena -- Now What?"
"The Government Wants Your Intellectual Property -- How It Gets It and What You Need to Know to Prevent It"
E-Mail – The Limitless Power of the “Send” Key
"A Guide for the Preparation of Claims Against the Government -- How to Spot, Preserve, and Perfect Claims to Maximize Your Rightful Revenue Under a Government Contract"

Invitations will be sent separately for each seminar. We ALSO welcome suggestions concerning other possible topics of interest.

Early Steps Toward a Streamlined Export Control System: Proposed Changes to the ITAR and EAR

Sheppard Mullin — Wed, 16 Nov 2011 14:48:50 -0800

By: Curt Dombek & Reid Whitten

On November 7, 2011, the U.S. State Department published a proposed rule amending the International Traffic in Arms Regulations (“ITAR”) by narrowing the categories of aircraft and related equipment controlled on the United States Munitions List (“USML”). Concurrently, the U.S. Department of Commerce, Bureau of Industry and Security (“BIS”) published a proposed rule adding five new Export Control Classification Numbers (“ECCNs”) to the Commerce Control List, which lists items controlled under the Export Administration Regulations (“EAR”). The two rules are linked, as the new ECCNs in BIS's proposed rule will cover those items carved out of the ambit of ITAR controls by the State Department’s proposed rule.

Background

The two interrelated proposed changes represent the second step in the Administration’s ongoing Export Control Reform Initiative (the “ECR” or the “Initiative”). The ECR began in earnest when BIS published a proposed rule on July 15, 2011—discussed on this blog—that laid out a regulatory construct for harmonizing the USML and the CCL. According to a Department of Commerce website, the Initiative will be implemented in three phases: Phases I and II will reconcile various definitions, regulations, and policies for export controls, and build toward Phase III, which is envisioned to create a single control list, single licensing agency, unified information technology system, and enforcement coordination center.

In a supplement to its proposed rule, the State Department explained that the proposed revisions to the USML and CCL are only an interim step toward reconciling definitions and integrating the ITAR and EAR control lists. Advance notice of the November 7 proposed rule was released in December 2010 and comments received, as well as the Administration’s review of that advanced notice, suggested that fundamentally altering the structure of the USML by creating tiers and aligning it with the CCL, could create havoc in the carefully tailored compliance systems maintained by exporters and re-exporters. Therefore, the revisions proposed in these November 7 rules move toward a streamlined export control regulation regime, but do not fully implement the tiered levels of control that are envisioned eventually to develop out of the Initiative.

Under the structure laid out in the July 15 proposed rule, the November 7 proposed rules describe how certain military aircraft and related articles and technical data currently controlled under USML Category VIII—Aircraft and Associated Equipment—would be controlled under the CCL. In crafting these proposed changes, the U.S. Department of Defense performed a review of Category VIII of the USML in coordination with the Departments of State and Commerce. The review was designed to identify types of USML Category VIII articles that were either (i) inherently military and otherwise warranted control on the USML or (ii) common to civil aircraft applications, possessing parameters or characteristics that provide a critical military or intelligence advantage to the United States, and that are almost exclusively available from the United States. Generally, if a Category VIII USML article did not fit either of these criteria, it was designated under one of the new ECCNs created by the rule proposed by BIS. If an article satisfied one or both of these criteria, it remained on the USML.

The Changes

The proposed changes are most notable for moving items from ITAR control (the USML) to EAR control (the CCL), after years of regulations that expanded the USML. The changes are not meant to weaken ITAR controls. Rather, the changes are designed to focus ITAR controls on protecting those items that will maintain a military advantage for the United States and to use the EAR to allow exporters to reach the same answers about permissible exports that previously were delivered by DDTC after a licensing process under ITAR.

ITAR

Currently, the USML covers generic parts for military aircraft, regardless of the item's military significance. In fact, the USML lists all parts, components, accessories, and attachments that are specifically designed or modified for a defense article, a blanket control from which there are certain exceptions. In essence, Category VIII controls almost every part of a military plane but the tires.

If the proposed changes go into effect, the USML will contain an affirmative list of specific types of parts, components, accessories, and attachments that continue to warrant control on the USML. The proposed USML Category VIII descriptions are honed to a specific list of items that the authors of the proposed rule believe have definite military significance. One catch-all style category that remains in the State Department’s proposed rule covers parts and components specially designed for what are essentially stealth aircraft. All other Category VIII parts and components that fall under the current catch-all ITAR control and are not specifically listed in the new rule will be moved to the CCL. This is a significant change that will remove a large volume of low level aircraft parts from ITAR control.

EAR

To accommodate the items moving from the USML, new categories of classification will be added to the CCL. The rule proposed by BIS states that the articles that no longer warrant control under Category VIII of the USML would be controlled under the CCL in five new ECCNs: 9A610, 9B610, 9C610, 9D610, and 9E610. In addition, a small category of military aircraft, and technology related to such aircraft, are currently controlled under ECCNs 9A018, 9D018 and 9E018; under the proposed rule, such aircraft and related technology would be controlled under the new ECCNs 9A610, 9D610 and 9E610.

These new ECCNs make up part of the “600 series,” a proposed class of EAR items created to control former ITAR items that do not otherwise fit an existing ECCN. The BIS proposed rule modifies the July 15 proposed rule by adding a general policy of denial for 600 series items for destinations that are subject to a United States arms embargo under the regional stability reasons for control.

There will also be a 10% de minimis rule for foreign products produced with 600 series items. The ITAR do not provide for de minimis treatment for any items currently listed on the USML, regardless of the significance or insignificance of the item to the end product containing it. In other words, under current rules, even the smallest, least significant ITAR item, if it forms part of any item not otherwise controlled for export, will be controlled under the ITAR. Under the proposed changes, however, a 600 series item may be exported without a license where that item is incorporated into a larger item not controlled for export under the EAR, so long as all the 600 series items comprise less than ten percent of the value of the larger item.

The parts and components in the 600 series will qualify for the Strategic Trade Authorization (“STA”) exception if they are intended for a government end user in one of 36 countries that are currently eligible under the STA exception.[1] This includes such parts or components that are exported to manufacturers in those countries that are producing end items for delivery to those governments. End items in the EAR 600 series (as opposed to parts and components) will be subject to review by BIS before they will qualify for the STA exception.

Other details concerning license exceptions for the 600 series are outlined in the proposed rule.

The Effect

The proposed changes will provide an increased opportunity for exporting and re-exporting items that are no longer subject to ITAR control to NATO-member and other countries qualifying for the STA exception. Exporters will be able to deliver parts and components for end use by these governments without the added time of waiting for ITAR licensing and addressing the other attendant complexities of ITAR compliance. Moreover, as EAR items, these parts and components could be incorporated in the manufacturing of civilian EAR end items and exported in accordance with the ECCNs for those end items (15 C.F.R. § 770 Interpretation No. 2), encouraging increased manufacturing and export as the components become part of less strictly controlled products. The application of the EAR de minimis rule will also encourage additional exports of these parts and components.

It is interesting to note that, under the proposed rules, a 600 series component could be made in the United States, manufactured into a larger civilian end product, and exported under the less restrictive ECCN of the end product. The same 600 series component, however, could be restricted for export, on its own, to foreign countries for manufacture into the same civilian product. This means that the new rules could also encourage manufacturing of some civilian products to move back to the United States – a welcome result for U.S. industry.

There is, in addition, the likelihood that some manufacturers will be relieved of ITAR registration requirements if all their products move to the CCL. Such exporters and re-exporters would also benefit from the elimination of Technical Assistance Agreements or Manufacturing License Agreements for the export of certain technology formerly controlled under the ITAR.

Conclusion

These proposed changes are only the early steps of a larger transformation, but the potentially broad effect of such a narrow shift illustrates just how much potential benefit may arise from the planned overhaul of the export control regulations. The devil is, as ever, in the details, and companies seeking to avail themselves of advantages provided under the proposed rules will need careful guidance to navigate these intricate, but potentially quite beneficial regulations.

Authored by:

Curt Dombek
(213) 617-5595
cdombek@sheppardmullin.com

and

Reid Whitten
(202) 469-4978
rwhitten@sheppardmullin.com

Sheppard Mullin partner Curt Dombek serves as an industry member of the President's Export Council Subcommittee on Export Administration, which is working on changes to the export control regulatory framework. The views expressed here are those of Sheppard Mullin's export control attorneys and do not represent the views of the Subcommittee.

[1] The STA exception provides an exception to the licensing requirement for the export, re-export, or transfer of specified items to a certain, enumerated countries that pose relatively low risk that the items will be used for a purpose that the license requirements were designed to prevent.

New Personal Conflict Of Interest Rules For Contractors

Sheppard Mullin — Wed, 16 Nov 2011 14:47:13 -0800

By Keith Szeliga and Christopher E. Hale

On December 2, 2011, Federal Acquisition Regulation Subpart 3.11 – Preventing Personal Conflicts of Interest for Contractor Employees Performing Acquisition Functions – takes effect. The new Rule requires contractors to screen for and prevent personal conflicts of interest when supporting Government acquisition functions. [1] The Rule also requires contractors to prohibit covered employees from utilizing non-public information for personal gain and to obtain from covered employees executed non-disclosure agreements prohibiting the dissemination of such information.

The Rule defines “personal conflict of interest” to include situations in which a “covered employee” has a financial interest, personal activity, or relationship that could impair the employee's ability to act impartially and in the best interest of the Government. Under the Rule, “covered employees” include the contractor's employees and self-employed individuals who perform an “acquisition function closely associated with inherently governmental functions.” Covered acquisition functions include supporting or providing advice or recommendations with regard to the following activities of a Federal agency:

(1) Planning acquisitions;

(2) Determining what supplies or services are to be acquired by the Government, including developing statements of work;

(3) Developing or approving any contractual documents, to include documents defining requirements, incentive plans, and evaluation criteria;

(4) Evaluating contract proposals;

(5) Awarding Government contracts;

(6) Administering contracts (including ordering changes or giving technical direction in contract performance or contract quantities, evaluating contractor performance, and accepting or rejecting contractor products or services);

(7) Terminating contracts; and

(8) Determining whether contract costs are reasonable, allocable, and allowable.

Examples of personal conflicts of interest covered by the Rule include: (1) financial interests of the employee and close family members or other members of the household, e.g., compensation, business and real estate investments, stock ownership, intellectual property interests; (2) employment and financial relationships, including seeking or negotiating prospective employment; and (3) gifts. The definition of “personal conflict of interest” excludes a “de minimis interest” that would not impair an employee’s objectivity, but the Rule provides no guidance in this area.

The Rule requires the insertion of standard contract clause 52.203-16, Preventing Personal Conflicts of Interest, in solicitations, contracts, and task or delivery orders awarded after December 2, 2011 for “acquisition functions closely associated with inherently governmental functions for, or on behalf of, a Federal agency or department.” Commercial item procurements are exempt from coverage as are procurements valued at or below the simplified acquisition threshold.

The Rule instructs contracting officers to modify existing task or delivery order contracts, on a bilateral basis, to include the new PCI clause for future orders. The contractor’s leverage in the “bilateral” negotiation of these changes, however, is virtually nonexistent. In the event a contractor refuses to accept such a modification, the contractor will not be eligible to receive any additional orders under the contract.

To comply with the new contract clause, Contractors are required to identify and prevent personal conflicts of interest through the following means:

(1) Have procedures in place to screen covered employees for potential conflicts of interest, including obtaining financial disclosure statements from such employees each time they are assigned to a new task;

(2) Prevent personal conflicts of interest, including by not assigning an employee to perform a task for which a personal conflict of interest has been identified, absent a mitigation plan or waiver (which may be approved only under “exceptional circumstances”);

(3) Prohibit use of non-public information accessed through performance of a Government contract by obtaining signed non-disclosure agreements from employees;

(4) Inform employees of their obligations to disclose and prevent personal conflicts of interest, not to use non-public information accessed through performance of a Government contract, and to avoid even the appearance of personal conflicts of interest;

(5) Maintain effective oversight to verify compliance with safeguards;

(6) Take appropriate disciplinary action against employees who fail to comply with conflict of interest policies;

(7) Report any violation to the Contracting Officer as soon as identified with a description of the violation and proposed actions to be taken in response.

Reportable violations are defined to include a covered employee’s failure to disclose a personal conflict of interest, use of non-public information for personal gain, and failure to comply with the terms of a non-disclosure agreement. Contractors will not be held liable for employee violations, provided they have taken “appropriate steps to uncover and report the violation.”

The Rule requires contracting officers to flow down these obligations in subcontracts exceeding $150,000 where the subcontractors' employees qualify as “covered employees.” However, prime contractors are not responsible for screening their subcontractors' employees.

The Rule has the potential to impose a significant compliance burden on contractors that provide contract acquisition and administration support services. To comply with the new rule, such contractors should, among other things:

Modify their codes of business ethics and conduct to include adequate coverage of PCIs
Draft and implement specific policies and procedures relating to the identification, prevention, and reporting of PCIs
Develop training materials to educate employees regarding their obligations relating to PCIs
Create a standard form financial disclosure statement that addresses all potential sources of PCIs
Review the adequacy of existing standard form NDAs vis-à-vis the requirements of the new rule
Update their standard form subcontracts to provide for mandatory flow-down of the new contract clause

We would be glad to assist you with any of these tasks and to answer any questions you may have regarding compliance with the Rule.

Authored By:

Keith R. Szeliga
(202) 218-0003
kszeliga@sheppardmullin.com

and

Christopher E. Hale
(213) 617-5513
chale@sheppardmullin.com

[1] The Rule addresses only personal conflicts of interest in supporting the Government's acquisition functions, and does not extend to other areas that are not so closely associated with inherently Government functions, i.e., functions that only the Government can perform. However, on November 2, 2011, the Department of Defense, the General Services Administration, and the National Aeronautics and Space Administration, in consultation with the Office of Federal Procurement Policy and the Office of Government Ethics, issued a request for information seeking comment on the question of whether the regulations should be expanded to other contractor activities. Comments are being accepted until January 3, 2012.

The 2011 Bribe Payers Index: Another Important FCPA Compliance Tool

Sheppard Mullin — Wed, 16 Nov 2011 14:46:27 -0800

By John M. Hynes

On November 1, 2011, Transparency International (“TI”) released its 2011 Bribe Payers Index (“BPI”), which ranks the countries whose companies are most likely to engage in bribery when doing business abroad. The BPI can serve as an important tool for companies in their efforts to avoid violations of the United States Foreign Corrupt Practices Act (“FCPA”).

TI is a global organization dedicated to fighting against corruption. To that end, TI publishes various surveys and indices regarding the levels of transparency and corruption in countries around the world. In addition to the BPI, the TI publishes the well known Corruption Perception Index (“CPI”), which ranks countries by their perceived level of government corruption, as well as other tools meant to measure corruption, transparency and governance in countries around the globe.

While the CPI ranks governments by their willingness to take bribes, the BPI ranks countries by their home companies' willingness to pay bribes. Though they use different methodologies and are meant to measure different sides of corruption, the BPI and CPI correlate strongly to each other, showing the relationship between the two sides of corruption in each country.

Purpose, Methodology and Results of the Bribe Payers Index Survey

The BPI was first published in 1999 and includes two measurements: (1) the likelihood that companies based in 28 countries around the world engage in bribery when doing business in other countries (the “Country Rankings”) and (2) the likelihood of such bribery occurring in particular business sectors (the “Sectoral Rankings”).

The Country Rankings

The Country Rankings aspect of the BPI ranks “28 of the world's largest economies according to the likelihood of firms from these countries to bribe when doing business abroad.” Put another way, the Country Rankings focus on the “supply side” of international bribery, or bribes paid by the private sector in the countries covered.

Russia and China received the lowest scores of the 28 countries surveyed, indicating that business executives perceive Russian and Chinese companies to be the most likely to engage in bribery when doing business abroad. The countries with the lowest BPIs on the list, and thus whose companies are perceived to be most likely to pay bribes when doing business abroad, and their corresponding BPIs are as follows:

28. Russia (6.1)

27. China (6.5)

26. Mexico (7.0)

25. Indonesia (7.1)

23. United Arab Emirates (7.3) (tie)

23. Argentina (7.3) (tie)

The Netherlands and Switzerland tied with the highest score, showing that the respondents perceived companies based in those countries to be the least likely to pay bribes when transacting business abroad. The countries with the five highest scores and their corresponding BPIs are as follows:

1. Netherlands (8.8) (tie)

1. Switzerland (8.8) (tie)

3. Belgium (8.7)

4. Germany (8.6) (tie)

4. Japan (8.6) (tie)

United States companies ranked as the 10^th least likely to pay bribes when doing business abroad with a BPI of 8.1. Some of the United States' most important trading partners not included in the top or bottom five (reported above) ranked as follows:

6. Canada (8.5)

8. United Kingdom (8.3)

11. France (8.0)

13. South Korea (7.9)

19. Taiwan (7.5)

The Sectoral Rankings

The Sectoral Rankings measure the likelihood of companies to bribe when doing business abroad in 19 particular business sectors. Of those sectors, the Sectoral Rankings found that bribery was most likely to occur in the following sectors:

19. Public works contracts and construction (5.3)

17. Utilities (6.1) (tie)

17. Real estate, property, legal and business services (6.1) (tie)

16. Oil and gas (6.2)

15. Mining (6.3)

The finding that bribery is perceived to be most prevalent in the public works contracts and construction sphere is not new. The large size of the contracts, unique nature of each project, and large number of players involved in each project renders the sector vulnerable to bribery. Such characteristics make it easier to hide and inflate additional expenditures and make the tracing of payments more difficult.

The Sectoral Rankings also evaluated how often the following three different types of bribery occurred in each sector: (1) bribery of low-ranking public officials (e.g., to speed up administrative processes or facilitate the granting of licenses) (“Petty Public Corruption”); (2) improper contributions to high-ranking public officials and politicians to achieve influence (“Grand Public Corruption”); and (3) bribery between private companies (“Private Corruption”). Again, answers were given on a five-point scale and converted to a 10-point scale.

The survey found that Grand Public Corruption was the most common of the three types of bribery surveyed, leading the pack in 17 of the 19 sectors examined. Not surprisingly, such bribery was perceived as the most common form of bribery in the five sectors in which corruption in general was seen as most prevalent (see above). Petty Public Corruption was found to be almost as common as Grand Public Corruption across the 19 sectors and Private Corruption was found to be almost as high as both forms of public corruption.

Relationship of the Bribe Payers Index to the Foreign Corrupt Practices Act

The Foreign Corrupt Practices Act Generally

The FCPA provides for civil and criminal penalties for bribing foreign officials for the purpose of securing an improper advantage in order to obtain or retain business. In addition to civil penalties, an FCPA violation can lead to prison time for individuals and large fines, disgorgement of profits, imposition of monitors, loss of export licenses and suspension from doing business with the U.S. government for companies.

The FCPA prohibits corrupt payments through third parties, such as consultants, sales agents, resellers, joint venture partners and distributors, provided that the defendant company knew or should have known of the third party's intent to make a corrupt payment.

Additionally, merger and acquisition activity can create FCPA risks for the acquiring company. Knowledge of an FCPA violation committed by the target company prior to or after a merger or acquisition can be inferred if the circumstances of the violation were relatively evident and the acquiring company failed to undertake sufficient due diligence to uncover the fraud. Pre-merger or acquisition due diligence is therefore critical in assessing the FCPA risks associated with a merger or acquisition.

The Bribe Payers Index and Foreign Corrupt Practices Act Compliance

Companies should be mindful of the BPI in their FCPA compliance efforts. As noted above, U.S. companies can run afoul of the FCPA by reason of corrupt conduct of their business partners or merger/acquisition targets based in foreign countries provided that the company knew or should have known of the corruption. As a result, the U.S. government expects companies to undertake due diligence on such third parties before dealing with them to identify not only instances of corruption, but also their propensity to engage in corruption. Such due diligence should include, among other things, searching for the names of relevant persons and entities on U.S. government watch lists, researching media sources in both the U.S. and the third party's home jurisdiction to identify any negative press concerning the third party and interviewing relevant persons to gauge the third party's reputation in the business community, particularly with respect to potential corruption.

While companies should conduct a certain level of FCPA due diligence on every third party, the effort should be proportional to the FCPA risks posed by the particular transaction. The presence of certain risk factors such as the third party's home country and/or business sector may call for heightened due diligence. If a company ignores such risk factors and conducts the same minimum level of due diligence that it would perform on a less risky third party, and an FCPA violation by the third party is subsequently uncovered, the government may take the position that the company consciously disregarded the risk and thus violated the FCPA.

When thinking about engaging a third party to act on its behalf in a foreign country or merging with or acquiring such a third party, a company should consult the BPI to get a sense of how companies in that foreign country are perceived in terms of the risk of bribery and corruption and frame their due diligence plan accordingly. By way of example, a company should ensure to conduct the maximum level of due diligence on third parties in Russia and China because companies in those countries are perceived to be the most likely to engage in bribery and thus will pose the greatest risk of an FCPA violation. With respect to business sectors, companies should be particularly cautious when engaging or merging with or acquiring foreign companies in the public works and construction sector, as those companies are thought of as the most likely to engage in bribery.

Another aspect of the BPI that is important to FCPA compliance is its finding that Grand Public Corruption is the most common form of bribery across the 19 business sectors examined. Because this is the form of bribery that implicates the FCPA, this finding strengthens the relationship between the BPI and the FCPA. Thus, to further assess the FCPA risks posed by third parties, companies should refer to the specific part of the BPI survey measuring the likelihood of Grand Public Corruption in the third party's particular business sector. It is worth noting that Grand Public Corruption was deemed the most common form of bribery in the five business sectors perceived as the most corrupt in general, further highlighting the importance of conducting heightened FCPA due diligence when dealing with third parties in those sectors.

Conclusion

The BPI can serve as an important tool in a company's FCPA due diligence program for third parties based in foreign countries such as consultants, sales agents, resellers, joint venture partners, distributors and merger/acquisition targets. Knowing at the outset the perceived likelihood that such third parties will engage in corruption can help companies devise appropriate due diligence plans and thereby reduce the risk of violating the FCPA in the event that such a third party engages in corrupt conduct.

Authored by:

John M. Hynes
(213) 617-5430
jhynes@sheppardmullin.com

In Ninth Circuit, Whistleblowers Not Exempt From Confidentiality Agreements

Sheppard Mullin — Wed, 16 Nov 2011 14:45:45 -0800

By Anthony N. Moshirnia

Blowing the whistle on alleged fraud against the Government does not entitle an employee to loot and disclose her employer’s records in violation of a confidentiality agreement – at least not in the Ninth Circuit. In an opinion handed down in March of this year, the Ninth Circuit refused to adopt a so-called “public policy exception to confidentiality agreements to protect [qui tam plaintiffs]” who misappropriate documents from their employers ostensibly to buttress claims brought under the federal False Claims Act (“FCA”). U.S. ex rel. Cafasso v. Gen. Dynamics C4 Sys., Inc., 637 F.3d 1047, 1061-62 (9th Cir. 2011). Though this opinion has been on the books since Spring, it remains relevant, and worth keeping an eye on, as it provides powerful ammunition against FCA plaintiffs that continue to tout the “public policy” exception as though it were unassailable.

After learning that her job at General Dynamics C4 Systems, Inc. (“General Dynamics”) was going to be terminated, but before leaving her employment, Mary Cafasso “copied almost eleven gigabytes of data from [her employer's] computers in anticipation of bringing a qui tam action” under the FCA. When it discovered what Ms. Cafasso had done, General Dynamics filed suit in Arizona state court, seeking return of its purloined documents through a temporary restraining order (“TRO”). Apparently to avoid complying with the TRO, which the state court granted, Ms. Cafasso filed “a conclusory six page complaint . . . alleg[ing] FCA violations and retaliation.” She then used the FCA action to persuade the Arizona court to vacate the TRO and stay General Dynamics’ lawsuit.

When Ms. Cafasso’s FCA complaint was unsealed, General Dynamics counterclaimed alleging, inter alia, breach of contract arising from Ms. Cafasso’s misappropriation of documents in violation of a confidentiality agreement. In opposition to General Dynamics’ motion for summary judgment, Ms. Cafasso argued that General Dynamics had failed to prove contract damages and that, even if it had, her conduct was permissible because “[p]ublic policy grants [a] Relator a privilege in gathering copies of documents as part of an investigation under the FCA and gives [a] Relator immunity from civil liability based on claims against her for so doing.” U.S. ex rel. Cafasso v. Gen. Dynamics C4 Sys., Inc., 2009 WL 1457036, *13 (D. Ariz. May 21, 2009).

The trial court dismissed both of Ms. Cafasso’s arguments. It found that damages were established by the stipulated damages clause in the General Dynamics confidentiality agreement. After reviewing the parties’ competing legal arguments, the trial court also found that “public policy does not immunize Cafasso, [who] confuses protecting whistleblowers from retaliation for lawfully reporting fraud with immunizing whistleblowers for wrongful acts made in the course of looking for evidence of fraud.” The court concluded that “[s]tatutory incentives encouraging investigation of possible fraud under the FCA do not establish a public policy in favor of violating an employer’s contractual confidentiality and nondisclosure rights.”

On appeal, Ms. Cafasso did not dispute that her actions violated her confidentiality agreement with General Dynamics, but nonetheless urged the Court to “adopt a public policy exception to enforcement of such contracts that would allow relators to disclose confidential information in furtherance of an FCA action.” While noting that Ms. Cafasso’s position was not frivolous, and might apply “in particular instances for particular documents,” the Ninth Circuit found that Ms. Cafasso's data removal was not privileged.

The Ninth Circuit appears to have relied on two factors to reach this conclusion: the scope and volume of the documents Ms. Cafasso took. With respect to scope, the Ninth Circuit faulted Ms. Cafasso's “indiscriminate appropriation of documents,” referring to it as an “unselective taking [that included] attorney client privileged communications, trade secrets belonging to [General Dynamics] and other contractors, internal research and development information, sensitive government information, and at least one patent application that the Patent Office had placed under a secrecy order.” The Court was also troubled by the fact that Ms. Cafasso had taken over 11 gigabytes of data, noting that “the need to facilitate valid claims does not justify the wholesale stripping of a company's confidential documents.” In sum, the Ninth Circuit found that an “exception broad enough to protect the scope of Cafasso's massive document gather in this case would make all confidentiality agreements unenforceable as long as the employee later files a qui tam action” – an unacceptable result.

While Cafasso stopped short of rejecting the public policy defense to data theft as a matter of law, it certainly provides a new avenue to FCA defendants attempting to prevent qui tam relators from benefitting from extrajudicial discovery.

Authored By:

Anthony N. Moshirnia
(213) 617-5503
amoshirnia@sheppardmullin.com

Longest Prison Sentence Yet in FCPA Case

Sheppard Mullin — Wed, 16 Nov 2011 14:44:33 -0800

By Thaddeus McBride & Cheryl Palmeri

On October 26, 2011, Joel Esquenazi was sentenced to 15 years in prison for committing and conspiring to commit both money laundering and violations of the Foreign Corrupt Practices Act (“FCPA”). Esquenazi is the former president of Terra Telecommunications Corporation (“Terra”), an international telecommunications company. According to the U.S. Department of Justice (“DOJ”), this is the longest prison sentence yet imposed in a case involving the FCPA.

In a 2009 indictment, the DOJ alleged that Esquenazi authorized payments of bribes by wire and intrabank transfers to successive Directors of International Relations of Telecommunications D’Haiti (“Haiti Teleco”), the Republic of Haiti’s state-owned national telecommunications company. The purpose of the bribes was to secure business advantages for Terra, including continuation of its connection to Haiti Teleco’s telecommunications lines, preferred telecommunications rates, and additional monetary benefits.

The indictment alleges that, to disguise the payments, Esquenazi caused them to be made for fictional “consulting services” to various shell or intermediary companies chosen by the Directors of Haiti Teleco. The payments were falsely recorded as “commissions” or “consulting fees” on Terra’s financial, banking, and accounting documents.

Carlos Rodriguez, the former executive vice president of Terra, was also sentenced to seven years in prison for his participation in the bribery scheme.

In addition to these lengthy prison sentences, Esquenazi was ordered to pay a $2,100 assessment, and he and his co-defendants are jointly and severally liable for restitution in the amount of $2.2 million. A lump sum of $2,100 is due immediately. While Mr. Esquenazi is incarcerated, he is obligated to pay toward the order 50% of any wages he earns in a Federal Prison Industries job or, if he does not have a job, $25.00 per quarter.

Esquenazi and Rodriguez are not the first to face imprisonment in connection with the Haiti Teleco scandal. In January 2010, Antonio Perez, a former controller at Terra, was sentenced to 24 months in prison for money laundering and conspiring to violate the FCPA. Juan Diaz and Jean Fourcand, two third-party intermediaries, were also sentenced to 57 months and 6 months respectively for receiving and transmitting bribery payments.

“This sentence . . . is a stark reminder to executives that bribing government officials to secure business advantages is a serious crime with serious consequences,” said Assistant Attorney General Lanny A. Breuer of the DOJ’s Criminal Division. “As today’s sentence shows, we will continue to hold accountable individuals and companies who engage in such corruption.”

We think the Terra case is notable because it underscores the Government’s willingness to go after individuals, especially senior managers of companies involved in bribery schemes. The DOJ has said repeatedly in public settings—and most senior managers would likely agree—that the possibility of prison time is a highly effective deterrent.

The case is also notable because of the apparent cooperation between the DOJ and the Haitian authorities, which continues the trend of the U.S. government working in tandem with authorities in foreign countries—even less-developed countries like Haiti—to bring enforcement actions.

The lawyers for Esquenazi and Rodriguez indicated both men will appeal their convictions. According to Rodriguez’s lawyer, the appeal may be based in part on a statement issued by Haiti’s former Prime Minister, Jean-Max Bellerive, that defined Haiti Teleco as a private company. The FCPA, which prohibits illicit payments to “foreign officials,” would not typically cover a bribe solely to the benefit of a private individual.

The DOJ has traditionally taken an expansive view of what constitutes a government-owned or -controlled entity, and courts have been willing to defer to the DOJ’s view. See, e.g., Federal Judge Upholds DOJ’s Expansive Application Of FCPA (regarding the decision by a U.S. District Court in April 2011 to uphold the DOJ’s broad view of the term “instrumentalities” in a prosecution brought against Lindsey Manufacturing Company and several of its officers and employees). It therefore seems probable that a court would agree with the DOJ’s assertion that Haiti Teleco is a government-owned or -controlled entity, and thus that employees of Haiti Teleco would be considered foreign officials under the FCPA. In an environment of such vigorous enforcement, and given the significant penalties that may be imposed against individuals and entities alike, companies and individuals conducting business overseas need to ensure they maintain and follow robust anti-corruption compliance processes.

Authored By:

Thaddeus McBride
(202) 469-4976
tmcbride@sheppardmullin.com

and

Cheryl Palmeri
(202) 469-4941
cpalmeri@sheppardmullin.com

BCABA Bestows 2011 President's Award on Sheppard Mullin Attorney

Sheppard Mullin — Wed, 16 Nov 2011 14:43:39 -0800

By John Chierichella

On October 26, 2011, Ryan E. Roberts of Sheppard Mullin was recognized by the Board of Contract Appeals Bar Association with its 2011 President’s Award. The award is given annually to the individual who has made the most significant contribution to BCABA during the previous year. Mr. Roberts received the award for his work in developing and editing the BCA Case Digests – a recurring addition to the BCABA’s quarterly publication, The Clause. Mr. Roberts oversees a staff of 18 authors who summarize every substantive decision of the ASCBA, CBCA, and PSBCA. The most recent editions of The Clause can be found here, and a complete list of awardees can be found here.