In February, the U.S. government published and called for public comment on a new proposed Federal Acquisition Regulation (FAR) that would require companies doing significant business with military or civilian agencies to establish and maintain ethics programs and training for company employees. The public comment period expired in late May, and the final FAR rule is expected at any time.

The new rule will require companies doing business with the federal government to (1) adopt a written code of ethics and business conduct; (2) establish an employee ethics and compliance training program; (3) implement an internal control system; and (4) display agency Office of Inspector General hotline posters in common work areas and on any website used to provide information to employees. The proposed rule is only applicable to companies holding at least one government contract or subcontract over $5 million in value and 120 days or more in duration. It also exempts “commercial item” contracts from the new requirements.

The new FAR rule includes a contract clause, “Contractor Code of Ethics and Business Conduct,” that provides the government with remedies for noncompliance that include the withholding of contract payments and the loss of contract award fees for the noncompliant period. It also requires the clause be flowed down to subcontracts in excess of $5 million.

The new contract clause included with the proposed FAR rule describes the attributes of an appropriate system of internal controls. Specifically, the internal control system must facilitate timely discovery and disclosure of improper conduct in connection with government contracts, and it must ensure that corrective measures are promptly instituted and carried out. In addition, the rule provides the following examples of desirable internal controls:

• Periodic reviews of company business practices, procedures, policies and internal controls for compliance with the contractor’s code of ethics and business conduct as well as the special requirements of government contracting
• An internal reporting system, such as a hotline, through which employees can report suspected improper conduct, and written instructions that encourage employees to do so
• Internal and external audits, as appropriate
• Disciplinary action for improper conduct
• Timely reporting to appropriate government officials of any suspected violations of law or any other irregularities in connection with government contracts
• Full cooperation with government agencies responsible for investigations or corrective action

Notably, the new FAR rule makes no mention of the U.S. Sentencing Guidelines that, since 1991, have prescribed what the Sentencing Commission believes constitutes an effective ethics and compliance program. In its comments on the proposed rule, the Department of Justice stated that the Sentencing Guidelines “should serve as the baseline standard for a contractor’s code of ethics and business conduct,” and also recommended that the new FAR provision reference the Guidelines to ensure that “the federal government speaks with one voice on corporate compliance.” Given the Justice Department’s prominent role in the investigation and prosecution of corporate malfeasance, it’s likely the final FAR rule will refer to the Sentencing Guidelines as the appropriate standard for business ethics programs.

While companies will be permitted to fashion their ethics programs to fit the size of their business and the extent of their contracts with the federal government, the proposed rule does not address whether employees involved only in commercial contracts also must including employee ethics — has become critically important to company executives and shareholders hoping to protect their companies from similar problems and liabilities. The new FAR rule appears to be the latest evidence of a continuing trend toward common standards — dictated by congressional legislation or government regulations — for prudent corporate governance.

State and local governments, which typically mirror the federal procurement model and often follow suit with their own brand of acquisition reform, can also be expected to now issue similar mandates for contractor ethics programs. All told, any company that relies on government contracts should be making plans to get its compliance house in order or risk losing an important customer. On the up side, a company that establishes a sound business ethics program whether its business is dedicated to government or commercial enterprises, is likely to reap the benefits of this prudent investment in corporate governance.