If you are a contractor that interacts with both the Department of Defense and “electronic parts,” it is time to grab the caffeinated beverage of your choice, crack open 79 FR 26,092, and begin the bone-tingling read that is sure to keep many supply chain managers up at night. Implementing the requirements found in the National Defense Authorization Acts for FY2012 and FY2013, the DoD’s counterfeit parts rule was finalized and published in the Federal Register on May 6, 2012. Effective immediately, the new series of regulations apply to defense contractors using, relying on, or selling to the DoD an “electronic part,” as that term is now newly defined.  Although it may spoil the ending and break the cardinal rule of reading any thriller, we provide here the “Cliffs Notes” version of the regulations’ lengthy preamble and the key takeaways of the new Rule and its proposed application.

• The Rule’s applicability is “limited” to “counterfeit electronic parts” and “suspect counterfeit electronic parts.” As defined in DFARS 202.101, “electronic parts” refers to “an integrated circuit, a discrete electronic component …[and] includes any embedded software or firmware.” They are suspected to be counterfeit when “credible evidence (including but not limited to visual inspecting or testing) provides reasonable doubt that the electronic part is authentic.” The part is deemed “counterfeit” when found to be

an unlawful or unauthorized reproduction, substitution, or alteration that has been knowingly mismarked, misidentified, or otherwise misrepresented to be an authentic, unmodified electronic part from the original manufacturer, or a source with the express written authority of the original manufacturer or current design activity, including an authorized aftermarket manufacturer. Unlawful or unauthorized substitution includes used electronic parts represented as new, or the false indication of grade, serial number, lot number, date code, or performance characteristics.

• The Rule applies to full and modified CAS-covered prime contractors.  Thus, while the clauses proscribed in the new Rule are generally not intended to be applied or included inprime contracts for the acquisition of commercial items, CAS-covered contractors who supply electronic parts will still be required to establish and maintain an acceptable counterfeit electronic part detection and avoidance system.

• Mandatory flow down of the rule applies to subcontractors at “all levels in the supply chain.” The rule expressly includes subcontractors providing commercial items or commercial off-the-shelf (“COTS”) items. The flow down is thereby not limited to only CAS-covered subcontractors and will require that subcontractors maintain counterfeit electronic parts detection and avoidance systems of their own.

• Covered contractors are “required to establish and maintain an acceptable counterfeit electronic part detection and avoidance system” that will be evaluated.  The Rule requires contractor’s detection and avoidance systems to address twelve identified criteria at the risk of withholding of payments should they fail.  The most notable criteria include:

1. Training of personnel – as noted in the Rule’s preamble, this criterion was purposely left vague to provide contractors with the “the flexibility to determine the appropriate type of training … based upon each contractor’s assessment of [existing] programs and capabilities…and what more is needed.”

2. Inspection and testing of electronic parts –This criterion is undeniably vague. The Rule’s preamble recognizes that not all electronic parts are to be treated equally and contractors should test or inspect “dependent on the source of the electronic part.” The test, however, needs to include criteria for acceptance and rejection and must be performed “in accordance with accepted Government- and industry-recognized techniques.” The Rule offers no more specificity and the Federal Register preamble requires the contractor to “make risk-based decisions based on supply chain assurance measures.”

3. Use of suppliers that are the original manufacturer, sources with the express written authority of the original manufacturer or current design activity, including an authorized aftermarket manufacturer or suppliers that obtain parts exclusively from one or more of these sources. – Avoiding defining what is a “trusted supplier,” the Rule’s preamble notes the existence of “a categorization of what types of suppliers may be deemed ‘trusted’ and therefore treated differently from other suppliers.” This criteria could be used to inform the testing and inspection criteria discussed above.

4. Processes for maintaining electronic part traceability – This criteria imposes on the contractor mandatory certification and traceability processes that would enable supply chain managers to trace the parts through the supply chain back to the original manufacturer.  Although not imposing its use, the clause suggests a “item unique identification” (“IUID”) as an example of such a process.

5. Methodologies to identify suspect counterfeit electronic parts and to rapidly determine if a suspect counterfeit electronic part is, in fact, counterfeit; – Again, very little guidance is offered by DoD on how best to address this criterion but the Rule’s preamble suggests “[t]he Contractor may elect to use current Government- or industry-recognized standards” as a way to meet this requirement.

6. The reporting and quarantining of counterfeit electronic parts and suspect counterfeit electronic parts – Reporting of counterfeit and suspect counterfeit parts are expected to be provided to the Contracting Officer and to the Government-Industry Data Exchange Program (“GIDEP”) whenever the Contractor becomes aware of, “or has reason to suspect” that an electronic part purchased by the DoD contains or may be counterfeit. But note, not only are contractor’s required to self-monitor their own electronic parts, the Rule also requires contractors keep abreast of other counterfeiting trends and specifically, “detection and avoidance techniques contained in appropriate industry standards, and using such information and techniques for continuously upgrading internal processes.”

• The counterfeit electronic part detection and avoidance system will be assessed and evaluated.  The system employed by the contractor will be evaluated by DCMA’s Contractor Purchasing Systems Review Group and the DCMA Quality Assurance Representative at the request of the Administrative Contracting Officer. If the system is found wanting and a deficiency “significant,” the Rule’s preamble notes that “the purchasing system may be disapproved, and a withholding of payments can result.”

• The cost of counterfeit electronic parts and related rework/remedies are unallowable.  The Rule establishes a new DFARS cost principle, 231.205-71, making the cost of counterfeit electronic parts, suspect counterfeit electronic parts, and corrective/remedial actions to address such parts unallowable. The Rule provides for three exceptions that may be met for counterfeit-related costs to be allowed:

1. The contractor has a reviewed and DOD-approved operational system to detect and avoid counterfeit parts and suspect counterfeit electronic parts;

2. The counterfeit electronic parts or suspect counterfeit electronic parts are government-furnished property; and

3. The contractor provides timely (i.e., within 60 days after becoming aware) notice to the Government.

In terms of scope, the new Rule imposes a significant burden and significant amount of risk on contractors. The lack of clarity in many of its directives, especially in terms of the processes and systems it dictates, provides for some flexibility but also leaves plenty of room for refinement as the Rule matures and is tested by both the Government and contractors. Those who sell electronic parts to DoD should make every effort to clarify – in writing – the Rule’s effect on their supply chain management processes with their respective Administrative Contracting Officers until additional guidance (or unfortunate examples) are available.

And lest you think that such efforts will be confined to DoD, be prepared – Section 712 of the National Aeronautics and Space Administration (“NASA”) Authorization Act of 2014 (“the Act”), recently passed by the House, contains similar counterfeit parts legislation.  If enacted, the budget requires the NASA Supplement to the Federal Acquisition Regulation (“FAR”) be revised to address the detection and avoidance of counterfeit electronic parts in much the same manner as the new DoD rule.