The market for government contracts is a rich one. Every year federal, state and local governments award trillions of dollars to corporations. As a result, the recent epidemic of corporate misbehavior, lobbying and political corruption scandals and controversial payments to, and actions by, government contractors is not surprising.

“Both the general public and shareholders are demanding greater transparency in key areas of interaction Between government and the private sector.”

In turn, this has sparked a wave of legislation designed to combat improper influence in how these lucrative contracts are awarded. At the same time, both the general public and shareholders are demanding greater transparency in key areas of interaction between government and the private sector.

Recent cases suggest that enforcement is beginning to catch up with the laws. Corporations can no longer afford to turn a blind eye to these recent legislative efforts, which are broad-ranging and have created a patchwork of sometimes overlapping legal obligations. Some of these are obvious safeguards, such as limiting or barring political contributions and gifts and requiring disclosure of any contributions, communications or gifts to government officials.

Another group of obligations isn’t so obvious. This group applies the registration and reporting requirements of lobbyists directly to officers and employees of a company. It also treats political contributions of certain officers and employees of a company as contributions by the business itself.

This means, for instance, that if one of your company’s executive team members gives a well-intentioned donation to a political candidate this election year, your company could be breaking the law.

Because the penalties for noncompliance can be severe and in some cases trigger additional obligations imposed under the Sarbanes-Oxley Act, corporations need to ensure that they have an internal corporate governance strategy and compliance program in place both to prevent violations before they occur and limit liability after the fact. If not, business leaders could soon be asking the government official knocking on their door, “What do you mean I’m a lobbyist?”

GOVERNMENT CONTRACTORS UNDER THE MICROSCOPE

Over the past few years, there has been an increase in the number of restrictions to the political activities of government contractors. These restrictions are generally directed at three areas of activity: 1) political contributions; 2) communications; and 3) gifts.

Restrictions on the first group, political contributions, have aptly been termed “Pay-to-Play” laws. These are directed at countering the perception that campaign contributions are an implicit quid pro quo that buy corporations a chance to “play” the government contractor game.

These new laws could limit or completely ban any political contributions by current or aspiring government contractors. Again, these laws are especially tricky for businesses because of provisions that attribute contributions by officers, subsidiaries or employees of a corporation to the corporation itself.

PAY-TO-PLAY LAWS

While specific restrictions vary widely by jurisdiction, in many instances Pay-to-Play legislation consists of two laws. The first is a “prohibition” law, which may ban or restrict the amount a contractor or potential contractor may contribute to an elected official, candidate, policy-maker or political party. The second is a “disclosure” law, which supplements the prohibition by requiring contractors to report their political contributions to the proper officials.

These prohibitions and disclosures become more complicated by “attribution” rules. Attribution rules don’t just affect the company’s employees, they also apply to contributions made by the family members of a company’s directors or officers, its Political Action Committee or any parent or subsidiary business. So, even if the company’s Chief Operating Officer’s husband donates to a political candidate, the entire company could be heading towards legal headaches.

For example, a Kentucky-based highway contractor recently entered into a settlement with the Attorney General’s office after one of its employees pleaded guilty to making illegal contributions during the last gubernatorial campaign – a felony offense. The Attorney General stated that the company “knew or should have known” about the illegal contributions by its employee and that the case “[s]ends out the message that the law must be complied with and those who would try to circumvent it face very, very stiff fines and possible jail time.” As part of the settlement, the contractor paid the State of Kentucky $250,000.

New Jersey, which along with New York has some of the best-developed Pay-to-Play laws in the United States, enacted its Pay-to-Play law in 2004. In order to add transparency to how contracts are awarded, this law, known as “Chapter 19″, limits political contribu-tions by a business that either currently holds, or is bidding on a government contract worth over $17,500 in any level of New Jersey government.

Following the enactment of Chapter 19, former New Jersey Governor Jim McGreevey signed into law an order which created even stricter standards for contracts with the Executive Branch. Both this order, known as Chapter 51, and Chapter 19 comprise the “prohibition” part of New Jersey’s Pay-to-Play laws.

The “disclosure” section of New Jersey’s Pay-to-Play law came about in 2006. Chapter 271, as its known, requires disclosure of contributions made by a contractor in two instances: 1) to the government entity that will award a contract worth more than $17,500, if the contract is not awarded pursuant to a fair and open process; and 2) to the Election Law Enforcement Commission (ELEC) in an annual report if a business has received $50,000 or more in New Jersey government contracts within a calendar year, whether sole source or competitively bid.

Specifically, Chapter 51 disqualifies contractors from Executive Branch contracts who have made contributions to the governor or a candidate for governor within a certain timeframe.

ELEC went even farther and imple-mented New Jersey’s Pay-to-Play laws into two subchapters. One deals with the Executive Branch contracts and the other to address contracts with state agencies in the Legislative Branch, counties and municipalities. In each subchapter, the rules state that a “business entity” is prohibited from making a contribution of $300 or more to certain state candidates or political parties during the term of a contract which may have a relationship with that candidate’s elected office or with the political party of which that candidate is a member.

Getting down to business, what does this all mean for your company? Well, both subchapters define “business entity” as one of several things – any natural or legal person, business, corporation, professional services corporation, limited liability company, partnership, limited partnership, business trust, association, or any other legal commercial entity organized under the laws of New Jersey or any other state or foreign jurisdiction. However, the subchapter pertaining to the Executive Branch also considers the following as a “business entity”:

• All principals who own or control more than 10 percent of the profits or assets of a business entity or 10 percent of the stock in the case of a business entity that is a corporation for profit;
• Any subsidiaries directly or indirectly controlled by the business entity; and
• Any political organization organized under 527 of the Internal Revenue Code that is directly or indirectly controlled by the business entity (i.e., a PAC), other than a candidate committee or a political party committee.

This means that if your company is currently working on a contract project dealing with New Jersey’s executive office, it’s against the law for your top executives to donate $300 or more to the state Democratic Party. Any guess why? New Jersey Governor Jon Corvine belongs to the Democratic Party. If the governor was Republican, you couldn’t donate to the GOP, either. Just another worthwhile legal note to be aware of during this political season.

The law also adds a comprehensive disclosure component to New Jersey’s Pay-to-Play laws. In particular, a “business entity” must now disclose its contri-butions of over $300 to all political party committees and PACs in New Jersey, as well as specified candidate committees. As with the “prohibition” rules, this disclosure law has its own broad range of “affiliates” whose contributions must also be disclosed. These include:

• Persons with a 10 percent or more “interest” in the business;
• Any subsidiaries directly or indirectly controlled by the business entity;
• IRS Code section 527 New Jersey based organizations, directly or indirectly controlled by the business entity (i.e., a PAC); and
• All principals, partners, officers, or directors of the business entity and their spouses.

Noncompliance can result in both civil and criminal penalties. For example, any person who purposely conceals or misrepresents certain contributions is guilty of a crime of the fourth degree. A business that is found to have intention-ally made an illegal contribution or failed to disclose a contribution may be liable for a penalty of up to the value of the con-tract with the public entity for up to five years. Penalties for late filing of political contribution reports range from $6,000 for the first offense up to $12,000 for each subsequent offense. A contractor may also be debarred for engaging in the commission of a criminal offense related to obtaining or attempting to obtain a public contract.

Fortunately, New Jersey’s Pay-to-Play laws provide contractors with certain safe harbors, protecting them from liability under the law, provided the contractor acted in good faith.

For example, if a contractor makes an inadvertent contribution to a member of the Executive Branch, and later discovers that the donation would disqualify his or her company from earning a contract, the violation may be cured if the contribution is fully reimbursed within 30 days from the date it was made. For contributions directed at any other governmental ac-cess point besides the Executive Branch, a business entity has 60 days from the date a contribution is made to make a written request for reimbursement, and receipt must be had by the business entity within 60 days. The failure to cure a mistake within the allotted time renders the contribution a willful and intentional violation.

It’s not just talk, either. There’s bite behind all that bark. New Jersey has shown a particular willingness to enforce its Pay-to-Play restrictions. In late 2007, New Jersey disqualified 24 vendors for making improper contributions in violation of its Pay-to-Play laws. And, importantly, the state doesn’t discriminate based on the size of the outfit. The businesses that were disqualified ranged from a large, politically connected law firm that represented members of the State Legislature to small-time electricians and landscapers. The disqualifica-tions resulted in a ban from government work for up to 18 months.

For corporations with a presence within New Jersey, an additional layer of complexity is created by the enactment of numerous municipal ordinances that may differ from the state law. As of the beginning of 2008, 21 counties within New Jersey had posted Pay-to-Play ordinances on the New Jersey Secretary of State’s website. It is likely that other municipali-ties or government entities within these counties, such as boroughs, townships, school boards, sewage authorities and utility authorities, will follow this trend and adopt their own Pay-to-Play rules. Without a system to monitor this patch-work of evolving regulation, a bank can quickly expose itself, its investors and its employees to significant liability.

Many jurisdictions are starting to regulate communications between contractors and government officials by amending the definition of “lobbying” to include attempts to influence “administrative action”, which is often defined as a decision regarding the award of a government contract.

These “vendor-as-lobbyist” laws are now forcing corporations to register their individual government sales-team members as lobbyists, which may require both the corporation and the employee to comply with other restrictions applicable to lobbyists. Finally, many jurisdictions have enacted strict laws specific to contractors that limit or require disclosure of gifts to public officials. These laws can make the most mundane of gifts problematic.

SO WHAT’S A COMPANY TO DO?

An effective strategy for managing the risks associated with political activity can be a corporate compliance program based on the United States Sentencing Guidelines and the guidelines set forth by the “Thompson Memo” – the DOJ’s guidelines that advise prosecutors on when to bring criminal charges against a company because of its employees.

While there is no “one-size-fits-all” compliance program for corporations, an effective program should incorporate the following seven elements:

1. Establish standards and procedures to prevent and detect criminal conduct;
2. Provide appropriate oversight by high-level personnel;
3. Exclude high-risk individuals from government activity;
4. Establish effective communication of standards and procedures to all level of employees;
5. Monitor and audit for compliance, and provide and publicize a system for reporting potential or actual wrongdoing without fear of reprisal;
6. Provide incentives and discipline to promote compliance, including discipline of individuals responsible for the failure to take reasonable steps to prevent or detect an offense; and
7. Respond appropriately to violations and take steps to prevent similar conduct, including modifying the program.

No program can guarantee 100 percent compliance, but the critical factors in evaluating any program are whether the program is adequately designed for maximum effectiveness in preventing and detecting violations by employees. It’s also important that management effectively enforces the program, rather than tacitly encouraging or allowing employees to engage in misconduct to achieve business objectives. Institutional commitment is generally the factor in any program’s effectiveness. Given increased attention to political law violations, as well as the complexities of compliance across numerous jurisdictions, such compliance programs should be a priority for all corporations that are politically active or contract with the government.

After all, while New Jersey’s pay-to-play laws are attracting the spotlight today, many other states are following suit. Yours could be next.

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Paula Hopper, Counsel in the Raleigh, NC office of Kilpatrick Stockton, has extensive experience advising clients on matters relating to election law, campaign finance and government ethics at both a state and federal level. Ms. Hopper regularly advises corporations and its management about political law compliance programs, corporate compliance policies and executive training. Paula can be reached at phopper@kilpatrickstockton.com

Robert Hensley, an Associate in the Raleigh, NC office of Kilpatrick Stockton, advises clients on matters relating to election law, campaign finance, corporate compliance and government ethics at both state and federal levels. Robert can be reached at rhensley@kilpatrickstockton.com