By Joseph E. Houchin, Government Contracts & Defense Industries

Key Takeaways:

• Heightened Government Attention to Fraud Risk
  • The U.S. Government Accountability Office (GAO) recently released a report identifying ongoing vulnerabilities to fraud in the defense contracting sphere. The GAO Report called for enhanced efforts by the Dept. of Defense (DoD) to prevent and manage risk of defense contracting fraud.
• Anticipated Increase in Government Investigations
  • Under enhanced fraud risk scrutiny by the DoD, government contractors of all sizes should anticipate increased government investigation efforts.
• Opportunity for Defense Contractors to Protect Themselves by Implementing or Enhancing Compliance Programs
  • Although recommended in any environment, and especially in anticipation of the DOJ’s heightened attention to investigating, prosecuting, and/or civilly litigating fraud, defense contractors should consult outside counsel on how to implement or bolster an effective compliance program in order to best protect the company against claims of fraud.

U.S. Government Accountability Office Releases Report Calling for Enhanced Efforts by the DoD to Curtail Procurement Fraud

North Carolina and Virginia are proud to claim one of the largest collective military footprints in the country, boasting prominent bases for all four military branches. Due to the size and influence of the Hampton Roads installments as well as Fort Bragg in Fayetteville and Camp Lejeune in Jacksonville, defense contracting needs are a major economic driver for the region. Contractors both large and small benefit from the opportunity to provide goods and services to the Department of Defense.

But as government contractors are well aware, this opportunity also carries risks. As Supreme Court Justice Oliver Wendell Holmes Jr. wrote in 1920: “Men must turn square corners when they deal with Government.” What Holmes meant, and what subsequent court decisions have made clear, is that government contractors are held to a higher standard of business ethics than in private business affairs. Negotiating and bidding tactics, billing procedures, and contract interpretations, which would pass muster in the private sector, can run afoul of the law when the Government is the customer (or provides funding) and the penalties can be severe – up to and including criminal prosecution, suspension, and debarment. Even well-intentioned defense contractors with dedicated compliance programs must be vigilant in enforcing and updating those programs in order to avoid a situation that exposes the company to potential violations of the False Claims Act, Procurement Integrity Act, Anti-Kickback Statute, and a host of other legal and regulatory requirements. Contractors need to understand that courts have found contractors civilly and criminally culpable not only for intentionally fraudulent conduct but also for conduct that is described as “deliberately ignorant” or “willfully blind.” Even successfully defending an investigation can be a long and expensive process.

GAO Report on Department of Defense Fraud Risk Management

Recently, the U.S. Government Accountability Office (GAO) released a report detailing the Department of Defense (DoD) response to the fraud risk posed by the defense procurement industry. According to the report, made public in September 2021, the DoD spent almost $422 billion on defense contracts in Fiscal Year 2020. The GAO has long been critical of the DoD’s procurement processes and highlighted continued vulnerabilities for waste, fraud, and abuse. To demonstrate the level of susceptibility, the GAO report referenced a 2018 release from the DoD indicating that from 2013 through 2017, the Government recovered $6.6 billion from defense contracting fraud cases. Additionally, roughly 20 percent of all ongoing DoD Office of Inspector General investigations relate to procurement fraud, further highlighting the pervasiveness of the problem.

The GAO report issued a series of recommendations intended to curb the increasing risk of fraud and criticized DoD failures to adopt or fully implement necessary measures. Specifically, the report identified that after a year of efforts to implement a DoD Fraud Reduction Task Force, 11 of the 59 DoD component organizations (including the Army) had failed to designate a Task Force representative. Additionally, DoD risk management policies do not incorporate GAO-recommended fraud risk assessments which, according to the report, hampers identification of all potential fraud risks and leads to inappropriately designed control mechanisms. While fraud risk assessments are shared with risk management officials within various DoD agencies, the GAO pointed to lingering misunderstanding about roles of responsibility by various stakeholders in addressing fraud risk and response.

Prevalence of Procurement Fraud and Future Trends

The GAO report highlighted a number of common fraudulent schemes contractors should guard against within their organizations including illegally selling counterfeit parts, billing for work not performed, submitting fraudulent proposals, and disguising improper conflicts of interest. The Government routinely prosecutes these types of schemes around the country and such conduct frequently appears in indictments across the Eastern Districts of North Carolina and Virginia, which are home to a heavy defense presence. These fraudulent practices result in taxpayer loss and expose violators to criminal prosecution as well as civil actions, including under the False Claims Act, in addition to monetary and other penalties. The GAO report warned that perhaps most problematic is that without appropriate DoD oversight in place, the unchecked opportunities for fraudulent conduct could breed an environment for escalating impermissible behavior.

With the growth of defense procurement expenditures and the unaddressed problems cited in the GAO report, the problem of contracting fraud is likely not going away anytime soon. Total defense contract costs increased from $320 billion in FY 2016 to $422 billion in FY 2020. During FY 2020, the DoD paid out contracting funds to roughly 47,000 contractors. Outside of fiscal fraud, the GAO report pointed to national security risks caused by defense contractors engaged in fraudulent dealings deliberately designed to conceal problematic background information or mask foreign-owned business interests.

The GAO report suggested that the scope of procurement fraud is far greater than the cases that are identified and prosecuted. Nevertheless, investigators and prosecutors remain busy inspecting and charging a wide range of fraudulent procurement conduct. Fraud associated with bid-rigging, bribery of military personnel, and falsifying documents routinely makes headlines as indictments are made and convictions secured against contractors engaged in wrongdoing.

Government Response to Fraud Risks

The Defense Criminal Investigative Service (DCIS) within the DoD Office of Inspector General is primarily responsible for uncovering defense contracting waste, abuse, and fraud. DCIS works together with the appropriate U.S. Attorney’s Office (USAO) to investigate and, if appropriate, initiate prosecution. Branch-specific agencies like the Army’s Criminal Investigation Division can also raise and push cases to the USAO for review. Many cases originate through a hotline managed by the DoD which provides a confidential means for reporting suspected fraud. Even while DCIS and the USAO examine a specific case for potential contracting fraud, a range of administrative and contractual remedies may be utilized to protect against ongoing Government loss including contract termination and/or suspension and debarment from defense contracting. With increased funds allocated for DoD contracts and the industry’s inherent susceptibility for fraud, it can be expected that the Government will continue to actively prosecute and litigate fraud cases as they are identified and investigated.

Importance of Effective Compliance Programs and Investigation Response Strategies

Even for contractors without concerns about deliberate fraudulent practices within their company, the GAO report should serve as a wake-up call about the importance of effective compliance programs. The best defense to an investigation is to avoid one altogether by implementing and enforcing a robust compliance plan.

An effective compliance program should have a strategy in place in the event of a Government investigation. An investigation can originate in a number of different ways including a grand jury or Inspector General subpoenas, civil investigative demands, or requests to interview company employees. As a common technique, investigators might make unannounced home visits to company employees to request informal interviews. Regardless of what triggers an investigation, a well-developed compliance plan with a response strategy already in place will leave the company well-positioned to thoughtfully and intentionally respond to any such investigation. Including outside counsel in the response strategy to help manage the situation is highly encouraged in order to maximize the effectiveness of a company’s response. The company’s compliance officer can coordinate with outside counsel to gather, review, and produce any necessary responsive records and ensure that litigation holds are issued to retain relevant documents and suspend any normal file deletion procedures. Working with outside counsel at the early stages of an investigation helps set the foundation for a successful resolution.

A well-implemented compliance program will also train employees regarding best practices if asked for an interview by investigators, including what to expect and how to respond. Effective compliance policies will also outline appropriate record-keeping procedures ensuring protection of confidential and protected information. Outside counsel can help contractors preserve the attorney-client privilege throughout an investigation by controlling the flow of information and implementing joint defense agreements when applicable.

Self-Reporting Requirements and Implications

The GAO report acknowledged that violations can range from unintentional errors to sophisticated bribery and corruption schemes. The DoD maintains the Contractor Disclosure Program which provides defense contractors a method to police themselves and voluntarily report fraud violations. In fact, Federal Acquisition Regulation 52.203-13 requires mandatory disclosure where there is “credible evidence” of (1) an overpayment on a government contract; (2) a violation of federal criminal law in connection with a government contract or subcontract; and (3) failure to disclose violations of the civil False Claims Act in connection with any government contract or subcontract. Failure to disclose violations can be the basis for suspension/debarment.

Self-disclosures are made without any agreement regarding potential civil or criminal action by the Department of Justice. However, DOJ officials have previously gone on record encouraging corporate development of self-policing mechanisms and urging law enforcement to provide great consideration to companies with effective compliance programs. Voluntary disclosure or timely mandatory disclosure may help a contractor avoid debarment or limit False Claims Act damages and penalties as part of a negotiated resolution.

Defense contractors with questions about implementing or bolstering an effective compliance program should consult with experienced Government Contracts counsel. Additionally, contractors targeted for investigation or those who become aware of potentially fraudulent conduct within their organization need to immediately involve outside help to determine the scope of the matter and effectively respond.

The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2024.