Corporate Governance

CONSTRUCTION FIRMS: Targets for Enforcement Initiatives (Part 1)

Iraq and Katrina combine with existing trends to form a perfect storm
for construction firms that have government business

The meltdowns at Enron, Tyco, Adelphia and WorldCom and many other corporate scandals have produced an explosion of legal and regulatory responses the likes of which corporate America has not seen since the Great Depression. The Sarbanes-Oxley Act of 2002 (SOX) and the related SEC and NYSE/AMEX/NASDAQ rules are probably the best known in corporate offices and boardrooms. In addition, however, a series of other legal, regulatory and enforcement activities have combined to virtually mandate that management and boards of directors of both public and private corporations that do business with the government update and/or implement comprehensive and effective corporate compliance and ethics programs. As will be seen, a comprehensive compliance and ethics program is the most cost-effective means to establish a corporate culture of integrity and fair dealing; to help personnel at all levels of the organization understand their compliance and ethical obligations; to provide a well-understood process for identifying and addressing compliance and ethics problems before they fester and, perhaps most important, before they are reported to law enforcement authorities.

Compliance and ethics programs are not a panacea and they require frequent communication and a sustained commitment. In the long run, however, the cost and effort involved are drops in the bucket compared to the massive cost of a significant compliance failure.

On top of these well-known corporate scandals, that primarily focused on publicly traded, or employee owned companies, government enforcement and regulatory activities have been further ratcheted up by the problems of the massive government actions taken in response to the War on Terror, particularly in Afghanistan and Iraq and the devastation of hurricane Katrina. Although these two situations involve all manner of federal contracting projects and dollars, a significant portion of the response to each has been the increase in procurement of construction related services, including those of design professionals. Those companies, their employees and management are now at risk if they do not take affirmative steps to insure their compliance with government contracting requirements.

There exists today a convergence of requirements that goes beyond the formal adoption of codes of ethics, codes of business conduct, disclosure controls and internal controls that are required under SOX. While these are an integral part of sound corporate governance and an effective compliance and ethics program, they are only part of what should be done. A construction company, whether public or private, today must consider the broader aspects of effective compliance programs and sound corporate governance as a result of recent guidance from the Federal Sentencing Commission and from the Department of justice to name the two most prominent sources.

Recent federal guidance

In November, 2004, the United States Sentencing Commission issued a detailed update on its guidance concerning the elements of an "effective" compliance and ethics program. This guidance has become the standard by which most corporate compliance and ethics programs have been designed and operated. In addition, the Department of Justice adopted a formal policy requiring all federal prosecutors to take into account whether or not a company has an effective compliance and ethics program in making the decision whether or not to charge that company with a criminal violation. The standard that prosecutors will use typically will be the guidance from the Sentencing Commission.

Compliance and ethics programs need to consider and integrate diverse aspects of a company's business, legal and regulatory environment that go beyond the areas covered by the financial reporting focus of the Sarbanes-Oxley Act. In today's environment, we believe that all areas of significant potential risk and exposure need to be considered and analyzed. These risks and exposures range from the more obvious areas of Foreign Corrupt Practices Act and anti-money laundering (U.S.A. PATRIOT Act) compliance to the equally important areas relating to risks created by contracting with the government in times of crisis. As will be seen, the urgency of the government's response to the war in Iraq and Afghanistan and the Katrina disaster caused the suspension of many normal contracting procedures. Many companies responded promptly to the needs caused by both situations and short-circuited their own internal procedures. In that environment, some unscrupulous persons and companies took advantage to obtain contracts they could not, or would not, perform in accordance with regulatory requirements. Spurred on by Congress, the government is now coming after those companies with a vengeance. Many honest companies will be caught up in this process and suffer through the massive costs and damage to reputation caused by being targeted for investigation.

Compliance and ethic programs

Recent developments in Delaware corporate law, in conjunction with the Sentencing Commission guidelines, have placed greater emphasis on director and officer involvement and oversight. Under these cases, including the landmark Delaware Chancery Court decision in In re Caremark International Inc., 1 courts have held that directors cannot merely rely on the good faith of corporate employees, but could be held liable for failing to assure that appropriate information and reporting systems were in place at the company. The courts further suggest that directors and officers have an affirmative duty to ensure that a corporate compliance system exists, and that the absence of such a system may render directors liable for any losses caused by noncompliance with legal rules and regulations.

The importance of compliance programs in today's business environment is also underscored by statements by prominent legal jurists and writers and in commentaries to the American Law Institute's Principles of Corporate Governance ("ALI's Principles") and the American Bar Association's Model Business Corporation Act. The ALI's Principles, in addressing a director's duty of care, recognizes that compliance programs "represent a basic mechanism to assist the board in properly fulfilling its oversight role." Similarly, the ABA's Corporate Director's Guidebook recommends that directors "should assess whether the corporation has established and implemented . appropriate policies designed to provide reasonable assurance of compliance with applicable laws and regulations. 2

Ineffective compliance programs; False Claims Act liability

If the developments just outlined are not sufficient to induce construction companies that contract with the government to implement compliance and ethics programs, a recent Civil False Claims Act case in Pennsylvania should get their attention. For the first time, a federal court has held that an assertion that a company failed to maintain an effective corporate compliance program is sufficient, under the False Claims Act (FCA), to allege that the company submitted false claims with "reckless disregard" of their falsity, even though there is no allegation that upper management had actual knowledge that false claims were submitted. 3 As a result of this decision, United States v. Merck-Medco Managed Care, L.L.C., all companies that derive revenue from federal funding should ensure that they have compliance and ethics programs and that their programs are "effective" under applicable legal standards and industry practices.

Merck-Medco Managed Care, L.L.C. arose out of a civil action brought by the Department of justice under the False Claims Act law that provides the government with powerful tools to combat fraud, waste and abuse by recipients of federal funds. Under the FCA, companies that "knowingly" submit false claims paid with federal funds are liable for three times the actual damages suffered by the government, plus additional penalties of up to $11,000 per claim. These per claim penalties alone can snowball into astronomical amounts for construction government contractors, many of which submit thousands of claims for payment each year. What makes the FCA particularly risky to companies is that the government is not required to prove the company had actual knowledge that a claim was false. Instead, a company violates the FCA if it lacked actual knowledge but is found to have acted in "reckless disregard" or "deliberate ignorance" of the truth or falsity of its claims.a much easier legal standard for the government to meet. Because of this loosened "knowledge" requirement, companies that are merely sloppy or careless in the preparation of claims that later turn out to be inaccurate can get caught in a quagmire of complex litigation and substantial liability, even though they intended no wrongdoing.

In addition, the FCA poses onerous risks for construction companies that receive federal funds, because FCA litigation can be initiated not just by the government but by any person who discovers or has knowledge of allegedly false claims. The FCA allows individuals to act as "private attorneys general" and file FCA actions on the government's behalf and receive a percentage of any recovery. It is not uncommon for such plaintiffs.known as qui tam rise from the ranks of a company's disgruntled or recently fired employees. In recent years, relators in False Claims Act cases have sometimes received tens of millions of dollars from such cases.


Construction Firms - Part 2

Our thanks to this article's authors, Christopher Myers and Allison Feierabend of Holland & Knight.

Holland & Knight is a global law firm with more than 1,150 lawyers in 17 U.S. offices. Other offices around the world are located in Beijing and Mexico City, with representative offices in Caracas and Tel Aviv. Holland & Knight is among the world's 18 largest firms, providing representation in litigation, business, real estate and governmental law. Our interdisciplinary practice groups and industry-based teams ensure clients have access to attorneys throughout the firm, regardless of location.

Christopher A. Myers is chair of Holland & Knight's Compliance Services Team and a member of the firm's White Collar Defense Team. He is a former federal prosecutor and has experience in a broad range of complex matters affecting heavily regulated industries, including health care, government contracts, financial institutions, real estate, securities and other companies. He has represented clients with respect to matters involving civil and criminal fraud investigations, corporate governance, anti-money laundering, design and implementation of compliance programs, and administrative litigation. Mr. Myers is certified as an Anti-Money Laundering Specialist and as a Certified Compliance & Ethics Professional.

Allison V. Feierabend practices in the areas of government contracts and business litigation. Her government contracts experience includes bid protests, contract disputes, contractor claims, and counseling clients on diverse government contracts issues. Ms. Feierabend's protest experience includes a wide array of military and civilian agency procurements before the Government Accountability Office and United States Court of Federal Claims. Ms. Feierabend counsels large and small government prime contractors and subcontractors on a wide variety of procurement law issues including intellectual property and technical data rights, organizational conflicts of interest, Freedom of Information Act (FOIA) requests, the Berry Amendment, and flow-down clauses.

DISCLAIMER: This Corporate Governance article is provided as an informational resource and does not constitute legal advice. The information provided in this article is based on the laws in effect at the time the article was published. Laws related to this article's topics may change over the course of time. Visitors to this website should not rely upon or act upon this information without seeking professional legal counsel.

1 In re Caremark International, Inc. Derivative Litigation, 698 A.2d 959 (Del. Ch. 1996).
2 The importance of the board's involvement in insuring that an effective compliance and ethics structure exists is brought home by the recent settlement negotiations in the MCI and Enron shareholder actions, in which members of the boards of directors have been asked to contribute millions of dollars of their personal assets toward the settlements, in addition to the amounts available through Director and Officer liability insurance policies.
3 United States v.. Merck-Medco Managed Care, L.L.C., 336 F.Supp.2d 430, 440-41 (E.D. Pa. 2004).


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