February 10, 2006

Anatomy of Compliance Costs: The Boeing Cases

Holland & Knight Alert
Christopher A. Myers

True commitment to ethical behavior and compliance with laws and regulations is an important competitive advantage for government contractors. Yet, busy executives often view compliance and ethics programs only as overhead items that do not add to the bottom line and compliance officers as naysayers. Besides, they reason, the bad things that happen at other companies won’t happen at a “good” company with “good” people.

Boeing apparently believed that it was a good company. At a Leadership meeting on January 5, 2006, however, Boeing’s Executive Vice President and General Counsel, Doug Bain, laid out in very clear and powerful language the reasons why Boeing should have paid more attention to its compliance and ethics requirements. Bain’s speech was reprinted in the Seattle Times on January 31, 2006.

Bain described the initial shock of federal prosecutors and others that Boeing was under investigation for ethical violations: “They say, ‘You guys are the Boeing Company. You build things that are larger than life. You do things that are larger than life. You’re not a sleazy company. How did this happen?’ And the question that they always ask: Where was the leadership?”

By the end of six years of investigations, some of which are ongoing, Bain reported that the prosecutors had changed their view of Boeing. “ . . . [T]here are some within the prosecutors’ offices that believe that Boeing is rotten to the core... They talk to us about pervasive misconduct and they describe it in geographic terms of spanning Cape Canaveral to Huntington Beach, to Orlando, to St. Louis to Chicago.” He reported that, “The U.S. attorney in Los Angeles is looking at indicting Boeing for violations of the Economic Espionage Act, the Procurement Integrity Act, the False Claims Act and the Major Frauds Act... The U.S. attorney in Alexandria, Va., is looking at indicting us for violation of the conflict-of-interest laws. And both are looking to throw in a few conspiracy and aiding-and-abetting charges for good measure.”

How did this happen? How did a company with a strong reputation for good work and integrity, and highly knowledgeable about government contracts, end up with government officials, the public, and, as Bain acknowledged, many of Boeing’s own employees, believing that company officials, “just don’t get it.” Bain suggested there was an unwritten code of silence that resulted in employees failing to report suspected wrongdoing when they saw it and management not following up when reports finally reached them.

Included in Bain’s speech was a litany of the costs related to Boeing’s compliance failures. They far exceeded the tangible, out-of-pocket costs related to the investigations themselves.

  • For the alleged use of proprietary documents that a former Lockheed employee brought with him to Boeing:
  • It lost $1 billion of launches and was suspended from the launch business for 20 months.
  • Lockheed sued it for more than $1 billion.
  • Employees were fired and indicted.

According to Bain, a separate investigation into violations of conflict-of-interest laws related to the hiring of government employees:

  • Lost Boeing the U.S. Government tanker market, and made Italy its only customer.
  • Forced Boeing to recompete the C-130 AMP [Avionics Modernization Program] and the small-diameter bomb.
  • Caused the “biggest hit” to Boeing’s reputation.
  • Forced a senior executive to plead guilty to one felony count of aiding and abetting a violation of the conflict-of-interest laws, serve time in a federal prison, pay a fine of $250,000, and “forfeit approximately $5 million in equity-based compensation.”

Indirect costs related to these scandals included: denial of export licenses, potential loss of security clearances, re-suspension or debarment, potential prohibition of use and possession of explosive devices (used to trigger airplane door “actuators”), denial of State Department licenses, plus additional millions in fines and penalties.

Bain challenged the Company’s leadership to change the culture that allowed violations to occur without being reported internally until it was too late. “[I]f we’re not careful it can happen again.” Ethics and compliance are “all of our responsibilities.” He concluded: “Our job as the leaders of this enterprise is to establish a culture that ensures that there is no next time. And frankly the choice is ours.”

The costs Bain outlined, in terms of fines, penalties and lost business, as well as damage to reputation and the potential for future impacts on contractor integrity scoring, demonstrate the imperative for any government contractor to have rigorous compliance and ethics programs supported from the top all the way down to line employees. Contracting agencies do not want to be embarrassed. They want comfort that their contractors will help to prevent problems, and if they do occur, will resolve them appropriately and self-report when required. A culture of compliance and integrity, with no tolerance for violations, must be developed and enforced.

Strong compliance and ethics programs frequently serve as a “Get out of Jail Free” card. Federal prosecutors are required to consider a company’s compliance and ethics program before deciding to charge the company. If the company can demonstrate a true commitment to its program, prosecutors generally don’t indict. This is because a strong program can be conclusive evidence that the company did not have the required criminal intent. Moreover, a good program can help convince agency personnel that a criminal referral should not be made in the first place.

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