On October 12, 2017, the U.S. Securities and Exchange Committee (“SEC”) held an Investor Advisory Committee (“IAC”) meeting which largely focused on blockchain technology and the implications for securities markets. Based on the discussion at this meeting, the SEC is currently considering both the merits and risks linked to blockchain technology. Several IAC members in attendance expressed concern about the risk of fraud and abuse. To learn more about the presenters and topics discussed click here.
CFIUS recently published a summary of their 2015 CFIUS Annual Report to Congress. CFIUS is charged with reviewing foreign investments and advising the President on appropriate actions that may be necessary to suspend or prohibit foreign acquisitions, mergers, or takeovers which threaten to impair the national security of the United States. The Annual Report reflects a trend over the last two years that CFIUS is closely scrutinizing more foreign investment transactions and increasingly taking action. To learn the key points from the 2015 CFIUS Annual Report and other recent developments click here.
The pace at which government contractors are engaging in mergers & acquisitions has increased notably in recent years, as a stream of recent stories in the Washington Post and New York Times have reported. The acquisition of a government contractor frequently provides the buyer an opportunity to increase its market share and/or strengthen its capabilities in an existing industry. The acquisition may also allow the buyer to develop and market a new government contracting capability that was previously lacking from its portfolio.
In the past few months alone, several multi-billion-dollar acquisitions within the government contracts sector have been announced. For example, in September 2017, Northrup Grumman announced it would acquire Orbital ATK, a rocket and defense contractor. Orbital will bring new capabilities to Northrup’s portfolio, including a missile defense business line and the ability to launch rockets that carry satellites into space. The deal, worth $7.8 billion, will also allow Northrup to bolster its existing satellite capabilities.
Similarly, also in September 2017, defense contractors United Technologies and Rockwell Collins announced that they entered into a deal for United Technologies to acquire Rockwell Collins, an airplane electronic and avionics parts manufacturer, for $30 billion. Through the transaction, UTC Aerospace Systems, which will be renamed Collins Aerospace Systems, will bolster its aerospace capabilities and technology aerospace systems.
Companies and private equity funds seeking to expand their portfolios through the acquisition of large, medium, and small government contractors, however, must take particular caution through the due diligence process, because such acquisitions are fraught with potential land mines that can slow down or even disrupt the proposed transaction. When a company seeks to acquire an entity that holds government contracts, both parties must comply with several different sets of federal regulations to ensure that the government approves of the transaction; recognizes the buyer as a successor-in-interest for the seller’s government contracts or subcontracts; that all compliance obligations transfer to the buyer; and that the buyer is capable of fulfilling its new compliance responsibilities to the satisfaction of the government.
Some of the common issues that arise in government contracts mergers & acquisition include:
- Analysis of the remaining years and/or receivables under existing and prospective government contracts held by the entity to be acquired
- The novation or assignment of the government contracts from the entity to be acquired to the buyer
- The potential loss of small or other socio-economic preferences for the award of government contracts as a result of the acquisition
- Transfer of facility and top-secret clearances
- Intellectual property owned by the entity being acquired, or the government, and whether the rights can be transferred
- Organizational conflicts of interest, which may prevent the buyer from bidding on new contract opportunities
- Whether the company’s Federal Supply Schedules are up-to-date and compliant with specific regulations, like the Price Reduction Clause
- Which subcontracts and teaming agreements the entity to be acquired holds, and are they compliant and enforceable
- Foreign buyers: CFIUS notification and foreign ownership and control mitigation plans
- Past performance ratings of the company to be acquired by government agencies, and the impact of those ratings on the buyer’s ability to win other government contracts
- Prior suspensions or debarments that may affect the company to be acquired
- Disclosure of and indemnification for any contractual or regulatory non-compliance that predates the transaction, including violations of the False Claims Act
Failure to resolve these and similar compliance issues; to analyze and address any of the financial impact from any status change that may be caused by the transaction; or to obtain the necessary government approvals prior to transfer of government assets, may result in the loss of business opportunities for the buyer or merged entity, and in certain situations can result in suspension or debarment of the contractor, or civil and/or criminal penalties. Experienced and careful government contracts due diligence, however, can identify these and other risks in the transaction, ensure that the parties obtain adequate disclosures and indemnifications, make thorough and accurate representation and certifications, and obtain all necessary approvals from the government so that the proposed acquisition is successful and profitable.
The U.S. Court of Appeals for the Fifth Circuit recently issued a well-reasoned decision that takes the rare step of overruling a jury finding of False Claims Act (FCA) liability, and erasing the damages award of more than $663 million, after trebling and inclusion of civil penalties. See United States ex rel. Harman v. Trinity Indus. Inc., No. 15-41172, 2017 WL 4325279 (5th Cir. Sept. 29, 2017). The decision applied the U.S. Supreme Court’s decision in Universal Health Services, Inc. v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016), and held that the qui tam relators failed to establish the materiality element required to establish FCA liability.
In Harman, a qui tam relator (“Relator”) (a private citizen authorized by the FCA’s unique qui tam provisions to bring claims of fraud on behalf of the government) pursued claims that the defendants defrauded the government by falsely certifying that highway guardrails satisfied Federal Highway Administration testing requirements. The Relator’s claim amounted to an allegation that the defendants (collectively, “Trinity”) failed to disclose to the government modifications in their design and manufacturing process, and that the government would not have purchased Trinity’s guardrail products had it known about the changes.
A significant problem with Relator’s theory was that the government did not agree. In fact, after conducting its own analysis prior to trial, and after commissioning additional and independent testing following the jury verdict, the Federal Highway Administration repeatedly concluded that Trinity’s guardrails satisfied applicable standards and were eligible to be purchased and reimbursed by the federal government, despite omissions in the paperwork Trinity submitted to the government. Harman, 2017 WL 4325279, at *3, 4.
The Fifth Circuit analyzed whether those omissions – the purported fraudulent certifications, in Relator’s view – had a tendency to influence the government’s decision to pay for Trinity’s guardrails under the FCA’s statutory definition of materiality. See 31 U.S.C. § 3729(b)(4). Along with a detailed survey of FCA cases analyzing the materiality element, the court relied on the Supreme Court’s guidance in Escobar:
[I]f the Government pays a particular claim in full despite its actual knowledge that certain requirements were violated, that is very strong evidence that those requirements are not material. Or, if the Government regularly pays a particular type of claim in full despite actual knowledge that certain requirements were violated, and has signaled no change in position, that is strong evidence that the requirements are not material.
Harman, 2017 WL 4325279, at *11 (quoting Escobar, 136 S. Ct. at 2003-04). Applying this standard, the Fifth Circuit found that the government’s continued payments for Trinity guardrails, after being advised of alleged fraud and after conducting repeated testing, represented “very strong” and unrebutted evidence that Trinity’s certification inconsistencies were not material. Id. at *14, 16-17. In its decision, the Fifth Circuit cautioned against allowing relators to second-guess administrative decisions – like the decision to pay for Trinity guardrails – made by those elected and appointed through the democratic process. Id. at *17. In light of the unrebutted evidence to support the materiality element, the decision reversed the jury verdict and entered judgment as a matter of law for Trinity, providing complete vindication for the defendants. Id. at *18.
Key takeaways from the decision:
- The Supreme Court’s decision in Escobar has invigorated and provided heft to the “rigorous” materiality standard, both at the pleading stage and beyond, which should assist defendants in cases where factual allegations and evidence of materiality are weak or lacking.
- The Fifth Circuit’s opinion also provided a well-reasoned analysis strongly suggesting that Relator’s claims likewise could not satisfy the falsity element of FCA liability, in noting that disagreements over the quality of professional judgment are “not the stuff of fraud.” Id. at *9. This commentary is consistent with a burgeoning line of cases that underscore conventional wisdom that the FCA requires objective falsity, and that opinions, or mere disagreement among experts, in themselves are insufficient to establish falsity under the FCA.
- The Fifth Circuit’s opinion similarly provided a thoughtful analysis strongly suggesting that Relator’s claims could not satisfy the FCA’s scienter requirements. Emphasizing evidence that Trinity’s omissions from its certification paperwork were “inadvertent,” id. at *10, the Fifth Circuit’s analysis was consistent with the long line of cases indicating that honest mistakes, and even negligence, are insufficient to establish scienter to satisfy the FCA. Likewise, the decision noted that Trinity reasonably relied on the expert advice and opinions of its partner, id. at *11, which is consistent with FCA cases holding that reasonable reliance on experts or third-party professional analyses may undermine an attempt to establish the necessary “knowledge” under the FCA.
- Finally, the circumstances in Harman were relatively unique. Parties intending to rely on the Harman decision should compare the circumstances in that case with their own facts to evaluate the extent to which the Fifth Circuit’s comments may be applicable.
President Trump issued a new executive order (the EO) on September 21st that greatly expands the U.S. sanctions against North Korea, particularly secondary sanctions. Secondary sanctions apply to non-U.S. individuals and corporations and are imposed by the U.S. Secretary of the Treasury, in consultation with the U.S. Secretary of State. The EO establishes the following:
- Broad new criteria for designating non-U.S. persons for sanctions, including blocking their assets in the United States
- A “180 Day Rule” under which vessels and aircraft are barred from entering the U.S. for a period of 180 days after any port call or landing in North Korea
- Authority for the U.S. Department of Treasury’s Office of Foreign Assets Control (OFAC) to block any funds transiting accounts linked to North Korea that come within the U.S. or possession of a U.S. Person
- Authority for OFAC to impose sanctions on foreign financial institutions that knowingly conducted or facilitated, on or after the date of the EO: (i) any significant transaction on behalf of certain blocked persons; or (ii) any significant transaction in connection with trade with North Korea
To read more about the EO, click here.
Effective January 1, 2018, the minimum wage for federal contractors working on or in connection with contracts covered by Executive Order 13658 will increase to $10.35 per hour. The current minimum wage under Executive Order 13658 is $10.20 per hour. The Wage and Hour Division of the U.S. Department of Labor posted notice of the increased wage requirement in the Federal Register on September 15, 2017. See 82 Fed. Reg. 43408.
Contracts awarded on or after January 1, 2015, are subject to an increased minimum wage under the Executive Order. Contracts entered into prior to January 1, 2015, also generally will be subject to the Executive Order if, through bilateral negotiation, on or after January 1, 2015, the contract is renewed, extended, or amended pursuant to a modification that is outside the scope of the contract.
The minimum wage requirement of the Executive Order generally does not apply to federal grants, contracts with Indian Tribes, contracts for services that are exempted from coverage under the Service Contract Act, and construction contracts that are excluded from coverage under the Davis-Bacon Act. The Executive Order also excludes certain workers from entitlement to the minimum wage rate. For example, FLSA-covered workers who perform support work “in connection with a contract” for less than 20 percent of their hours in a workweek are not entitled to the increased minimum wage.
Federal contractors working on or in connection with contracts covered by the Executive Order should prepare to implement the increased wage rate in 2018, and should notify their workers of the applicable rate. Pursuant to 29 CFR 10.29, contractors are required to notify all workers performing on or in connection with a covered contract of the applicable minimum wage rate. A sample poster that contractors can display in a prominent or accessible place at the worksite is published at 82 Fed. Reg. 43412, Appendix B.
The UK competition regulator, the Competition and Markets Authority (CMA), will be conducting in-depth investigations of investment consultancy and fiduciary management services after the Financial Conduct Authority (FCA) initiated an investigation. The CMA has a wide range of powers enabling them to investigate and impose remedies. Industry participants should expect requests from the CMA to provide evidence and produce documentation. For those seeking a positive outcome, it is pertinent to begin compiling persuasive submissions and evidence. To learn more, click here.
Digital tokens, which used to be considered an unregulated “wild west”, are now facing Federal and State regulations. Over two weeks, the SEC suspended trading in company securities of three publicly-traded blockchain-related businesses. The SEC followed up the suspensions with releasing an Investor Alert advising investors to be cautious of companies that have been subject to a trading suspension. Companies that intend to issue digital tokens through an ICO need to be vigilant in ensuring that their offerings are clearly outside the scope of or fully compliant with the securities laws and regulations. To learn more click here.
The federal government dramatically has increased its spending in recent years on Internet of Things (“IoT”) devices, including biosensors that can gather medical and security data from soldiers and vehicles in the field; smart-building applications that reduce energy (such as desks that automatically power on when an employee scans his or her identification badge upon entering the building); and myriad other devices. Despite its rapid increase in procurement of IoT devices, the government has yet to adequately address critical issues, including risk and uncertainty about privacy and security of the devices.
In response, a bipartisan group of U.S. senators recently introduced the “Internet of Things (IoT) Cybersecurity Improvement Act of 2017” to improve the cybersecurity of internet-connected devices. The bill seeks to impose minimum security requirements on devices purchased by the U.S. government and has widespread industry support. Although the bill does not apply to consumer devices, industry experts anticipate the proposed legislation is a stepping stone to broader regulation of security and privacy in all IoT devices.
In co-introducing the legislation, Sen. Cory Gardner (R-Colo.) underscored the necessity for strengthening cybersecurity defenses with regard to the government’s purchase of IoT devices, stating: “As these devices continue to transform our society and add countless new entry points into our networks, we need to make sure they are secure from malicious cyber-attacks. This bipartisan, commonsense legislation will ensure the federal government leads by example and purchases devices that meet basic requirements to prevent hackers from penetrating our government systems without halting the life-changing innovations that continue to develop in the IoT space.”
The bill will require agencies to include certain contract clauses in any contract for the acquisition of internet-connected devices. The proposed contract clauses impose a number of new responsibilities on contractors providing the U.S. government with IoT devices. For example, vendors will be required to ensure that their devices are patchable, do not include hard-coded passwords that can’t be changed, and are free of known security vulnerabilities, among other precautions. The bill also indicates contractors will be required to comply with certain “cybersecurity coordinated disclosure requirements” and policies pursuant to agency guidelines to be prepared by the Department of Homeland Security National Protection and Programs Directorate.
Government contractors who manufacture and/or supply IoT devices to the federal government should monitor the proposed legislation, as its passage will result in new procurement requirements and will impose new and potentially burdensome obligations on contractors. The bill also may result in increased market competition among manufacturers on the security of their products. Critically, contractors also should be aware that the bill broadly defines “internet-connected device” as “a physical object that (a) is capable of connecting to and is in regular connection with the Internet; and (b) has computer processing capabilities that can collect, send, or receive data.” Such an expansive definition will subject a wide range of suppliers and manufacturers to the terms of the legislation, particularly when not only end products but also their components are considered.
The bill has yet to be scheduled for markup or debate. Reed Smith will continue to monitor this developing legislation.
On July 10, 2017, the U.S. Senate placed the FY 2018 National Defense Authorization Act on its Legislative Calendar. This action means the historically must-pass legislation is now ready for amendment and debate. Just as it did last year, the Senate Armed Services Committee (“SASC”) has included two provisions focused on bid protest reform. Given the absence of these bid protest reform provisions from the House version of the bill, and the SASC press release and summary touting the Senate bill’s strengths, these provisions are unlikely to make it through to the final version of the bill. Nonetheless, larger government contractors should take heed of the inclusion of the proposed bid protest provisions, consider appropriately lodging their disagreement with the provisions, and work to ensure they are not included in future legislation – House or Senate.
These provisions would penalize contractors that file unsuccessful bid protests in DoD procurements. First, section 821 would require any defense contractor with revenues of greater than $100 million over the past year, which loses a protest, to pay the government’s costs of processing that protest. Second, the proposed Senate bill would require incumbent DoD contractors that file protests to have their payments above incurred costs withheld on any bridge or temporary contracts issued, if their protest resulted in the delay requiring a bridge or temporary contract. Such DoD contractors could then receive the withheld funding if the solicitation is cancelled by the agency or if the GAO upholds the incumbent’s protest.