Gaps in New DOD Counterfeit Parts Rules Raise Compliance Questions for Contractors

The U.S. Department of Defense (DOD) published, on May 6, 2014, its first set of final regulations imposing specific obligations on defense contractors and their suppliers for the detection and avoidance of counterfeit electronic parts. Those new rules represent an improvement over DOD’s initial proposal, but still expose contractors and their suppliers to substantial risks, especially when it comes to dealing with “obsolete” (i.e., out-of-production) parts that are no longer available through the preferred channels of the original manufacturer or its authorized distributors. A more extensive discussion of the new counterfeit electronic parts rules, and how they differ from DOD’s initial proposal of a year ago, is available here.

The new rules, and the accompanying discussion of them by DOD, provide some additional information for contractors regarding DOD’s expectations for their counterfeit part detection and avoidance systems. But there remain significant gaps in the rules that DOD has not filled in with guidance. Three aspects of the rule raise immediate compliance questions for affected contractors.

Evaluation of Contractor Systems

The proposed regulations did not describe the standards DOD would use to evaluate contractor systems for compliance with the system criteria, and DOD again declined to provide that guidance to contractors as part of the final regulations. Instead, DOD advised contractors seeking more guidance on the approval standards for counterfeit electronic parts detection and avoidance systems to await the publication of the ‘‘Counterfeit Detection and Avoidance System Checklist’’ that is still being developed by the Defense Contract Management Agency. Thus, contractors are left with the immediate challenge of developing and implementing counterfeit parts detection and avoidance systems that will pass a DCMA review, without yet knowing the specific standards against which DCMA will evaluate their systems.

Traceability Requirements

The rules require contractors to establish a traceability process for electronic parts that “shall include certification and traceability documentation developed by manufacturers in accordance with government and industry standards; clear identification of the name and location of supply chain intermediaries from the manufacturer to the direct source of the product for the seller; and where available, the manufacturer’s batch identification for the electronic part(s), such as date codes, lot codes or serial numbers.” DFARS 252.246-7007(c)(4). Yet such traceability documentation simply does not exist for many electronic parts already in the defense supply chain – including some parts in contractors’ existing inventory – and the required traceability information may be particularly elusive for so-called “obsolete” (i.e., out-of-production) parts. DOD’s refusal to “grandfather” electronic parts already on the shelf from the new traceability and authentication requirements may limit contractors’ ability to use existing electronic parts inventory on newly awarded DOD contracts, given that contractors may not be able to demonstrate the required traceability of such parts through the various intermediaries in the supply chain.  And what are contractors to do when attempting to procure obsolete electronic parts that have been out of production for years, if none of the available sources of that part can provide the required traceability through all the supply chain intermediaries back to the original manufacturer?

The Flowdown Requirement

Given the mandatory nature of the flowdown requirement, contractors may not be able to use commercial item suppliers who refuse to accept the flowdown requiring the supplier to adopt a counterfeit electronic part detection and avoidance system meeting the twelve system criteria specified in the DFARS final rule. Thus, the flowdown requirement could deprive contractors (and DOD) of access to the benefits of commercial technology and products.  Nor does the final rule provide guidance regarding how contractors will be expected to monitor their suppliers’ compliance with the flowdown requirements. Contractors themselves will have their counterfeit electronic parts detection and avoidance systems reviewed by DCMA; will contractors be expected to perform their own reviews of subcontractor systems?

DOD has announced that it will hold another public meeting on June 16, 2014, to discuss further implementation of its counterfeit parts policies, and it is possible that DOD will fill in some of these gaps through its ongoing outreach efforts or in one of the several open or pending rulemakings implementing other aspects of the counterfeit parts rules. Until such clarification is provided, however, contractors will be faced with the challenge of complying with new rules that are both onerous and – in key aspects – painfully opaque.