Guest Blogger: Jay Gallagher & Phil Seckman, McKenna Long & Aldridge LLP

Pursuant to an interim rule, published July 8, 2010, contractors awarded certain prime contracts and first-tier subcontractors under those prime contracts have been obligated to disclose, among other information, details regarding the total compensation of their five most highly compensated executives.  The interim rule represented a phased implementation of the 2006 Federal Funding Accountability and Transparency Act (Pub. L. 109-282) and its 2008 adjustments (Pub. L. 110-252).  The final rule, published July 26, 2012 and effective August 27, 2012, has made only minor adjustments to the interim rule despite significant public comments.

Absent the applicability of certain exceptions discussed below, based on the phased approach in the interim rule, as of March 1, 2011, any newly awarded prime contract valued at $25,000 or more must contain FAR § 52.204-10.  Pursuant to that clause, among other things, a prime contractor must report the names and total compensation (without regard to the limits on amounts treated as allowable costs) of its five most highly compensated executives for its preceding fiscal year.  Moreover, the prime contractor must report its first-tier subcontract awards valued at $25,000 or more through the Federal Funding Accountability and Transparency Act Subaward Reporting System (“FSRS”), and for each such subcontract, also must report the names and total compensation for the prior fiscal year of each of the five most highly compensated executives of such first-tier subcontractor.

The standard FAR clause also contains a definition for total compensation.  The definition is not necessarily an exhaustive list of sources of compensation, but includes both the cash and noncash executive earnings, including: salary and bonus; stock awards, options, and appreciation rights; earnings for services under non-equity incentive plans; changes in pension value; above-market earnings on deferred compensation that is not tax-qualified; and other compensation such as severance and termination payments that exceed $10,000.  Contractors should take care when determining whom in the organization qualifies as its executive and should consider establishing a procedure to ensure that changes in the identity of the highest paid executives are captured and accurately reflected in the required periodic reporting.

There is a change in the final rule that is likely to cause some consternation for contractors awarded classified contracts.  The interim rule had made clear, in FAR 4.1403(b), that the standard contract clause at FAR 52.204-10 was not required in classified solicitations and contracts.  The final rule makes an important change, now stating that the rule does not require the disclosure of “classified information.”  In other words, classified contracts no longer are likely to be exempt from the reporting requirement and, therefore, may include FAR 52.204-10 in the future.  Prime contractors facing this circumstance should assess, based on the security agreement for each classified contract, whether any of the information to be disclosed under the rule constitutes classified information.  Another consideration would be to seek approval prior to disclosure regarding the information to be released, consistent with DFARS 252.204-7000.

In addition to the foregoing, prime contractors awarded contracts subject to this requirement need to ensure that they flow appropriate requirements down to their first-tier subcontractors.  In this regard, prime contractors may wish to seek indemnity from subcontractors to address a subcontractor’s failure to provide accurate and updated information.

There are important exceptions to the requirement imposed on the prime contractor to disclose the compensation information called for by the rule.  Specifically, disclosure is required only if the contractor received:

  • 80 percent or more of its annual gross revenues, totaling at least $25 million in revenues from federal sources (i.e., contracts, subcontracts, loans, grants, etc.); and
  • The public does not have access to the contractor’s compensation information through reports filed with the SEC or IRS.

In addition to the foregoing, if the contractor or first-tier subcontractor had gross income, from all sources, of less than $300,000, the contractor or first-tier subcontractor is exempt from the reporting requirement.

These exceptions may enable some small businesses and private firms with modest government sales to avoid the reporting obligation.  Nonetheless, the very low $25,000 threshold for applicability of the rule and the fact that it is applicable to commercial item procurements and small businesses means that  executive compensation information will be required from literally hundreds of thousands of contractors.  Moreover, this information must be updated whenever it changes, and prime contractors in particular face yet another on-going compliance responsibility, which, given the statutorily-imposed low contract value threshold, would appear to be of questionable value to the U.S. taxpayer.

The preamble to the final rule makes clear that prime contractors are obligated to ensure compliance by their first-tier subcontractors.  Accordingly, primes will be imposing, by contract, that compliance obligation and any liability associated with non-compliance, on its first-tier subcontractors.  This makes sense given that the subcontractor is in the best position to ensure the accuracy of its information reported in FSRS and will also know when a change occurs that warrants updating reported information.  For these reasons, to the extent prime contractors have not already done so, they must have methods in place to ensure the required information is reported and periodically updated.

The rule represents a significant expansion of the public’s access to federal award information with the stated goal of reducing ‘‘wasteful and unnecessary spending.’’  From the perspective of the legislation’s drafters, this goal will be achieved by “empowering” the American taxpayer with information that can be used to demand greater fiscal discipline from both executive and legislative branches of the federal government.  In other words, government officials ostensibly will be less likely to earmark funds for special projects, because the public will have access to information regarding the transaction.

Avoiding unnecessary federal spending is, of course, a laudable objective.   Unfortunately, the cost of this new rule is estimated to exceed $20 million in added reporting costs and the FAR Council concedes the rule could result in anti-competitive behavior.  Specifically, contractors can use the information regarding subcontract awards and executive compensation to improve their competitive position in future procurements and to lure away executive talent.

Particularly important, however, is the fact that the rule continues the persistent retrenchment from the reforms in commercial item and commercial-off-the-shelf procurements represented by the Federal Acquisition Streamlining Act.  And, while the preambles to the interim and final rules state that 41 U.S.C. §§ 1906, and 1907 (which require affirmative findings by the FAR Council to impose the requirements of new regulations on commercial item or commercially available off-the-shelf item procurements, respectively) were considered when making the decision to impose the reporting requirement on commercial procurement, the actual justifications in the preambles are bereft of any meaningful analysis.  75 Fed. Reg. 39,414 (July 8, 2010).

Only time will tell, but at this point there is no evidence that the taxpayers are using the newly disclosed information to realize the legislators’ vision of greater fiscal discipline from the executive and legislative branches.  In its absence, the estimated cost required to implement the rule appears likely to achieve just the opposite of its intended objective, i.e., more, not less, wasteful and unnecessary spending.

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