An earlier post urged developing states to require firms doing business with them to have procedures in place to prevent their employees and agents from bribing government officers, making false claims, or committing other corrupt or fraudulent acts during the execution of a government contract. Mandating that government contractors institute anticorruption compliance programs is an American innovation that works reasonably well there and is spreading to other nations. Here I advocate a second American effort to curb corruption in government contracting that has not worked well in the United States but can in developing states.
Since December 1, 2008, any firm contracting with the federal government of the United States has been required to report to the government employee overseeing the contract any “violation of Federal criminal law involving fraud, conflict of interest, bribery, or gratuity violations” it learns of. Federal Acquisition Regulations Sec. 3.1003. Firms must also disclose any civil violation of the False Claims Act, the law banning the knowing submission of a false claim to the government for payment. The failure to “timely disclose credible evidence” of either can result in the suspension of the contract or the firm being denied future contracts or both. The reporting requirement continues for three years after the contract is completed. Unlike the anticorruption compliance program regulation, the mandatory disclosure rule applies to all contracts regardless of size or time to execute; it covers all firms as well: small and medium as well as large.
The mandatory disclosure rule replaced a voluntary disclosure requirement the U.S. Department of Defense adopted in 1986. In its first decade the Defense Department recovered some $370 million in fraudulent and corrupt payments thanks to voluntary disclosures, but when the number of disclosures fell dramatically in the program’s second decade, the Defense Department’s Inspector General suspected firms were hiding wrongdoing, and reporting was mandated. It was also required of all firms contracting with the government whether for defense articles or not.
To say the rule has not been welcomed by the U.S. contractor community would be an understatement. Commentary published during or right after its consideration was harshly critical. (Click here and here for examples of such critical commentary.) One complaint was that government rule-makers had no evidence that voluntary disclosure was not working. Fewer disclosures were not proof that contractors were hiding violations; it was just as likely that thanks to the rule there were fewer incidents to report. Furthermore, a company that knew about a violation and did not report it was not likely to report simply because reporting was mandatory. If executives were not disclosing violations it was almost surely because they were complicit in them.
A second complaint with the rule was lawyerly lament about its vagueness. When was evidence “credible”? When was disclosure “timely”?
The extant evidence suggests the contractors’ complaints have merit. U.S. Department of Defense Inspector General reports show that close to 2/3rds of all disclosures involve minor infractions arising from labor overcharges. An employee of the contractor or one of its subcontractors will charge for working eight hours on the project when he or she only worked six. The Defense Contracting Audit Agency follows up on all such disclosures, and according to the contracting community, it has fallen behind in its more important work of auditing as a result of the flood of labor overcharge cases.
That the rule does not appear to be working well in the United States is no reason why developing states should not embrace it. Demanding a firm doing business with the government come forward with evidence its employees or agents corrupted or defrauded government will help developing countries combat corruption in an area where it is rife: the execution of government contracts. By alerting authorities to possible violations, it will help conserve on scarce enforcement resources and serve to inform law enforcers about types of fraud and corruption they may not have the time or expertise to root out on their own.
The objections raised to the U.S. rule are readily dispatched. Lawyer complaints about the vagueness of the terms “credible” and “timely” in the U.S. regulation are easily remedied. Drafters can either offer additional language clarifying what “credible” and “timely” means or they can write a bright line rule that, say, requires the disclosure of any evidence of wrongdoing immediately. To guard against a situation like that now prevailing in the Department of Defense, where investigators are chasing small, immaterial cases, the rule could make it clear that investigation of any disclosure will be at the discretion of the enforcement authorities.
American contractors’ strongest argument against mandatory disclosure was that on the evidence voluntary reporting seemed to be working fine. Among reputable U.S. firms reporting was an accepted practice, failure to do so if discovered risked a loss of reputation and business, and a firm that voluntarily reported a violation was not put at a disadvantage vis-à-vis its competitors for “everyone did it.” While there is no law in any developing state that this writer knows of that bars firms from voluntarily disclosing evidence of corruption, internet searches and discussions with anticorruption agencies in several nations has revealed no instances where a firm has come forward on its own to reveal evidence of wrongdoing.
It is not surprising that voluntary disclosure is unknown in developing nations. Neither the homogeneity of firms characteristic of U.S. contractors, the strong, disciplining effect of reputation on their conduct in the U.S., or other characteristics of American procurement markets that created a favorable environment for voluntary disclosure are found in developing states. Developing countries contract with firms from many different nations, and firms from different nations have differing norms of behavior about fraud and corruption. The absence of shared norms makes voluntary disclosure unlikely. A reputable firm doing business in a developing country cannot be sure a voluntary disclosure would not put it at a disadvantage when competing against firms who do not disclose. Hence it has no incentive to disclose any violations by its employees or agents.
The benefits of repeat business, which lies behind concerns about reputation, also provide little or no incentive to disclose violations. Being blacklisted by the U.S. government can be a severe blow to a firm’s financial future, for the U.S. procurement budget is large and likely to remain so in the future. Thus there is a powerful incentive to comply with the U.S. government’s anticorruption and integrity rules. On the other hand, even if a firm executing a contract in a developing state is found to be corrupt or fraudulent, a risk often not great given the limited enforcement resources in many developing states, being blacklisted by a poor country with a small procurement budget may be of little concern.
Developing states should mandate that any firm with which it contracts disclose any evidence it discovers that its employees, agents, or subcontractors has violated any provision of the national anticorruption law. An easy change to procurement law or regulations that would provide one more way to combat corruption.