On January 21 the Supreme Court issued a significant opinion on federal campaign finance law and regulation.  The Court ruled that the First Amendment to the Constitution on free speech protects corporate speech as much as individual speech.

Accordingly, corporations, labor unions and even certain types of trade and business associations may now make unlimited “independent expenditures” and engage in “electioneering communications” regarding federal candidates.

However, the court did not overturn the restrictions on direct campaign contributions, including in-kind contributions, thus ensuring some continuing role for corporate and labor union political action committees. Nor did the court modify the existing tax law restrictions applicable to non-profit organizations.

The court also did not modify the existing prohibition on contributions and expenditures by foreign nationals. Finally, while the court’s ruling addressed corporate and labor union spending, it ignored other restrictions on certain federal contractors, such as partnerships and sole proprietors.

The ink was barely dry on the decision before the President, congressional leaders and others criticized the ruling and questioned whether federal elections would be significantly changed because of the money that could now flow.

Notwithstanding the instant political response, federal election law practitioners are still studying the 163-page, split-court, decision to understand its effect. Similarly, the Federal Election Commission (FEC), and perhaps the IRS and others, will be required to update regulations that give implementation guidance. Nevertheless, many theories and questions are being raised concerning the potential impacts of this decision on the federal contracting community.

In a break from my traditional approach to this column, I will address some of those theories and questions.

How will federal government contractors respond?

While I’m no election law expert, my experience tells me that almost all federal contractors will await clear guidance from their election law experts about permissible conduct.  Companies may even defer until regulatory changes are made before taking action.

The reason for this is that most firms have become comfortable with the current system and have learned to operate with and within it.  The largest contractors, which have traditionally invested heavily in program or issue lobbying, will also carefully watch how key competitors are reacting to the decision.

However, some trade and business groups, or other, existing special interest organizations or that could be formed because of the Supreme Court’s decision, may not wait long to begin capitalizing on the decision, particularly in fundraising, even as they sort out new advocacy strategies.

Will this decision affect other regulations?

To answer, I look at three different sets of regulations. The first set comprises the primary FEC rules on campaign finance and campaign advocacy; since the Supreme Court’s decision focused specifically on the laws and restrictions relating to independent expenditures and “electioneering communications,” these regulations will certainly have to be changed.

The second set of regulations, such as the tax laws, is directly affected by the Supreme Court’s decision, though not specifically addressed by it. The extent of the impact on these rules will depend on how the FEC, IRS and other agencies interpret the scope of the decision.

Finally, there are numerous other regulations affecting government contractors, such as the FAR cost principles, that make certain “lobbying” and political advocacy costs unallowable for government contracts. I see no chance that these types of regulations will be changed – or need to be changed – based on the court’s decision. A host of other rules, such as those relating to conflict of interest, seem removed from the scope of the Court’s decision.  Accordingly, I don’t see them being addressed.

Will government customers start monitoring company actions?

Some have speculated that government customers will become aware of the advocacy actions of their contractors and that this awareness could translate into some form of informal disqualification in the evaluation or award selection. Despite the repeated efforts by some to show a link between campaign contributions and contract awards, given that campaign contributions must be reported publicly, I’m pleased that there is no evidence that campaign contributions –for president or Congress – have had any impact on an agency’s procurement evaluation or award decisions.

But I won’t discount the potential that some in government will be considering a candidate litmus test for contributions from government contractors seeking to do business with an agency or seeking congressional support for their program. Similarly, I won’t discount the potential that competitors might resort to providing such information to either agencies or congressional offices. But for the integrity of the federal procurement system, I hope to never see this behavior and trust that agencies would be broadly cautioned against it.

Will the decision change the composition of lobbying activities and actions by companies or trade associations?

I do not expect the decision to have a significant short-term impact in the government contract arena, which I follow broadly in terms of policy, regulations, and business. But I would expect single-issue organizations or broad advocacy organizations, such as the National Rifle Association or even the U.S. Chamber of Commerce, to immediately try to capitalize on the potential opportunities the decision provided.  They may, for example, increase fundraising outreach to affinity groups.

By contrast, traditional government contractors and advocacy associations with broad public policy agendas will probably proceed slowly. My view is reinforced by the statements by the President and members of Congress that they intend to either override the decision as quickly as possible or to blunt its impact through new regulations.

Given these policy dynamics, and the uncertain regulatory landscape, there may be only a limited window of opportunity for even the most aggressive advocacy organizations to dive into the openings created by the Court.  For most government contractors, the existing tools and techniques remain in place and have proven effective.

In my view, the long-term uncertainty about the legal compliance requirements outweighs the need for pushing the envelope to take immediate advantage of the court’s landmark decision.

And it is a one-way phenomenon for the most part.  When was the last time that you saw the withdrawal or the softening of regulation of contractors?

But we were wrong nearly a year ago when we prognosticated that regulation of contracting would rise as a secondary effect of the understandable loud calls to re-regulate with some stringency Wall Street and other financial services industries.  While still necessary–in terms of public opinion polls and the sincere or postured mutterings from Congress, and even some business leaders–it seems clear we will not see that. Somewhat reminiscent of health care reform, we are seeing a dilution in sentiment and political feasibility for making significant financial regulation a reality.

Not only officials of the last administration, such as Treasury secretary Hank Paulson, but also current officials have softened their stance on financial industry regulation.  As a result, financial regulation will turn out to be wimpier and partial. 

Accordingly, we do not see a marked increase of business regulation generally, including on federal contractors.  Again, we are talking about an acceleration in the pace and boost in stringency of regulation, not the pre-existing baseline trend to progressively more regulation of the industry.

So what? Now that the proposed regs are out , industry anxiety should decline, especially for firms that have been working this problem in advance.  Still, for all of industry, minefields can be expected because of plentiful gray areas and the potential misuse of the regs in some cases by civil servants and/or contractors.  But don’t get us wrong; the regs are needed; as always, the magic is in the “how.”

The scope of the regs is flawed by definition because they apply only to contractor activities that are “closely associated with inherently governmental functions” in the acquisition sphere.  Inherently governmental is hotly debated in general, but the still-gray line is clearer when it comes to acquisition support, in our view.  Nonetheless,  there has been no fresh guidance from OFPP since 1991.  OFPP has committed to issue an updated, crisper definition by the end of December.

The FY09 Defense Authorization Act only required OFPP to address personal conflicts of interest only in the acquisition area, even though they can intrude with great damage later on in the contracting cycle.  PCOI could make a big difference, for example, when it comes to:  the drawing of conclusions in studies of a diagnostic nature, the management of indicators that shape award-fee determinations, or in key contract staffing decisions.

In our view, there is actually little documented intrusion of personal conflicts of interest in acquisition; note the lack of specifics in claims that contractors are taking over governmental functions.  And to state the obvious, whatever contractors do, the government solicited the services.  You could almost say contractors have been drafted as the acquisition workforce shrank.  But some experienced contractor executives we know would rather give up business than be subject to draining intense scrutiny, doubt, and contention because they work in the acquisitiion zone.

Another  feature, far more good than bad, is that contractors make the calls and keep the records on personal conflicts of interest.  This includes the filing of annual financial disclosure forms, a process that government employees in policy- and acquisition-related positions have been used for around 15 years.

However, there is a problem because, faced with the same regulations, different companies will set the threshold of potential PCOI differently. Some will be conservative, others not.  This inconsistency echoes what we see in government, where agencies often differ, for example, in their tolerance for organizational conflicts of interest and the stringency of mitigation measures.

We see no way to achieve alignment–out of fairness and to protect the government’s interest–except by judicious audits every once and awhile.  But you can be sure that allegations will be used, out in the open, indirectly, or furtively by some companies and some civil servants who may want to keep the playing field other than level. We see this today in aspects of some significant acquisition (e.g., questionable choices of vehicle, cryptic statements of work, overly constrained evaluation factors, gamey sole-source justifications).  There is every reason to expect such games to be played with respect to personal conflicts of interest.

The defenses are:  career civil servants and political appointees who actually manage and act as alert stewards for the taxpayers, continued good-ethics behavior by the majority of contractors.  They recognize that in the long run there is far more to be gained from good values than looking the other way, or worse.

Reference: Federal Acquisition Regulation; FAR Case 2008-025, Preventing Personal Conflicts of Interest for Contractor Employees Performing Acquisition Functions. The draft appeared in the November 13, 2009 Federal Register. Comments are due by January 12, 2010.

On October 14 the FAR Councils issued two interim rules that will significantly shift the burden to contractors for demonstrating that costs incurred in cost-reimbursement contracts are billable to government contracts and that incentive award fees are properly earned. By congressional mandate, both rules apply government-wide and became effective immediately upon publication.

And both will have a significant impact on contractors and their business relationships.

Congressional concerns about “excessive pass-through” costs on contracts have risen since Katrina and since the Government Accountability Office provided several reports to Congress. Congress imposed similar restrictions on the Department of Homeland Security (DHS) in 2007 and on DoD in 2008 before imposing this restriction government-wide and those agencies already have rules on the books.Both agency-specific rules will be repealed when this interim rule is finalized.I covered the DHS rules in my June 2007column.

Excessive pass-through limitations.The first rule, “Limitations on Pass-Through Charges,” is designed to minimize the “excessive pass-through” of subcontractor charges and prime contract expenses when a substantial amount of actual work will be (or was) performed by subcontractors. For civilian agencies, the rule applies to cost-reimbursement contracts greater than the simplified acquisition threshold ($100,000). For DoD, the rule applies to certain fixed price contracts, and to cost-reimbursement contracts, greater than the threshold to obtain cost or pricing data ($650,000).

The rule requires that proposals disclose the total value of work to be performed by the prime and each subcontractor, respectively. If subs are to perform over 70 percent of the total value of work, additional detail is required on the prime’s indirect costs and profit/fee applicable to the subs’ work and a description of the prime’s“added value” to the  subcontractor’s work.It’s then up to the contracting officer to “determine” – by an analysis not described in the rule – if that added-value work is a benefit to the government.If not, those costs are “excessive” and will not be allowed.

Second, the rule provides that, if a subcontractor’s effort exceeds 70 percent of the value of the work actually performed, the prime must demonstrate to the contracting officer that the prime added value to the subcontracted work; if not, the “excessive” costs will be disallowed. Finally, where “excessive” pass-through costs are not allowable, even in certain fixed-price DoD contracts, the government is entitled to a price reduction equal to the amount of those costs in the contract price.

To monitor compliance, the rule gives the contracting officer access to subcontractor records to determine whether the subcontractor proposed, billed or claimed excessive pass-through charges.

Award fee restrictions. This interim rule imposes restrictions on the use and implementation of new  cost-reimbursement, award fee, contracts. No award fee contract may be awarded unless (i) all of the FAR limitations on
cost-reimbursement contracts are met; (ii) the government completes an award fee plan as required by the FAR; and (iii) the head of the contracting activity issues a “determination and finding” that addresses the three FAR suitability factors relating to incentive contracts.

Any proposed award fee must be linked to the contractor’s cost, schedule and technical performance as measured against the contractor’s objectives. A contractor’s performance will be ranked according to a five-level adjectival award-fee evaluation scale detailed in the interim rule. Each performance level assigns a fixed range of available fee percentages. Furthermore, no award fee can be earned if the contractor’s cost, schedule and performance is rated “below satisfactory.”No unearned award fee may be rolled over into subsequent rating periods.

Five agencies – Defense, NASA, Energy, Homeland Security, and Health and Human Services – award over 95 percent of all federal government award fee contracts, and many of the provisions in this rule are already used by these agencies. In addition, in December 2007, the Office of Federal Procurement Policy published a memo entitled “Appropriate Use of Incentive Contracts” providing additional guidance to agencies when considering using award fee contracts.

This past August, I testified on award-fee contracts before a subcommittee of the Senate Committee on Homeland  Security & Governmental Affairs. I’m pleased that several of my recommendations were adopted in this rule.

While their substance has been around in various forms for several years, these interim rules introduce new elements
and significant compliance challenges for both government and contractors. In both cases, the rules put a premium on up-front contractor planning and proposal disclosures, along with careful monitoring during contract performance. For example, a prime could demonstrate added value where it is integrating the work of several subcontractors and  synthesizing their input to meet government requirements, or, where it is providing the supervision, security controls and billing for several task-oriented small businesses.

Expect both of these new requirements to be included in all new contracts but you should strongly resist having them applied to existing contracts.

What’s a contractor to do?

First, examine your internal “make-buy” and small-business subcontracting processes and be sure they are up-to-date. Both of these processes are pivotal in the determination of “excessive” pass-through and contribute to your decision of what work will be done with your workforce and what will be subcontracted.

New proposals will have to address both the excessive pass-through requirements as well as the significant criteria that benchmark an award fee plan, if applicable.As a prime contractor, you will want to contribute to both elements. If you’re a subcontractor, be prepared to address how your efforts will add significant capabilities to the prime and be ready to
work with the prime on addressing both the “added value” they bring and the award fee criteria you contribute to during your teaming negotiations and the prime’s proposal submission.

Second, if either rule applies, all primes and subs should be particularly alert to the performance and compliance challenges that kick in immediately after contract award.By creating the necessary reporting and monitoring provisions from the outset, you significantly minimize the risk of losing substantial costs and fees during performance.

Finally, prime contractors should involve your key subcontractors and vendors early in the proposal strategy to ensure that they are familiar with your processes and decisions, as well as the critical importance of satisfying the compliance and performance obligations under both new rules.

With these rules, the government is further intruding into a contractor’s business relationships and further dictating how it will manage its prime contractor relationships. Those firms that promptly address the requirements of the new rules, that demonstrate the significant value they bring, and that pay attention to the cost, schedule and technical performance elements of the contract stand to minimize their financial risk exposure and maximize successful contract execution.