United States: The National Industrial Security Program Directive: Some Hits, Some Runs, Some Errors

Our Comments On The Proposed Rule

Our Comments On The Proposed Rule

On January 11, 2017, the Information Security Oversight Office ("ISOO") of the National Archives and Records Administration published a proposed rule amending the National Industrial Security Program ("NISP") Directive Number 1 ("Proposed Rule"), including provisions on Foreign Ownership, Control, or Influence ("FOCI") mitigation and negation. The Proposed Rule provides guidance to Federal agencies, but will have significant, if indirect, impact on foreign- controlled government contractors.

Having advised on hundreds of FOCI negation and mitigation cases over nearly 40 years, we understand how these programs work – and don't work. We decided, therefore, to file comments on the Proposed Rule. This Stroock Special Bulletin highlights some of the key issues in the comments we have filed.

A Single Cognizant Security Agency is a Good Thing

The Proposed Rule states that "the goal [of the NISP] is to have one responsible CSA [Cognizant Security Agency] for each agency and for each entity, to minimize the burdens that can result from complying with differing CSA procedures and requirements."

We agree. As a matter of administrative convenience, efficiency, and good order, limiting the oversight of a cleared entity to a single CSA is extremely important, and avoids the confusion that would follow if entities were answerable to multiple and disparate agencies. Departures from this rule should require an extraordinary showing of necessity.

No Carve-outs

The Proposed Rule, like the Executive Order on which it is based, makes clear that it does not supersede the authority of agencies to control classified information under a series of identified statutes and executive orders. Because the Proposed Rule is intended to harmonize agency policies, we believe it is prudent to make clear that this provision is not intended to operate as a "carve-out" for the identified agencies.

We've recommended that the Proposed Rule be amended to make clear that, although it does not supersede or supplant the authority of the identified agencies, this is only true in so far as the Proposed Rule conflicts with these statutes and orders, and that, to the extent possible, all agencies and departments should endeavor to facilitate Part 2004's goals: to encourage reciprocity, avoid duplication, and generally foster a uniform approach to industrial security across all government agencies.

Clarity is Needed Regarding Limitations on Entity Eligibility Determinations

The Proposed Rule would allow CSAs to complete eligibility determinations when a CSA cannot make an eligibility determination in time to qualify an entity for the procurement action that gave rise to the Government Contracting Activity's ("GCA") request. This is a good idea, in our view, and presumably would allow facility security clearance determinations to be banked and later activated without a new eligibility determination process, avoiding additional time, effort, and money to restart the process.

Assuming this reading of the Proposed Rule is correct, we've asked ISOO to make clear any intended limitations on favorable eligibility determinations, such as time limits on the eligibility determination (i.e., where no classified procurement is awarded to the entity), and

whether an eligibility determination requested by one GCA will be valid if a different GCA is first to provide a new classified contract award to the entity after the eligibility determination. These questions are certain to arise, and should be addressed in the final rule.

Criteria for Limited Entity Eligibility Determinations are Unclear

"Limited eligibility determinations" (a/k/a Limited Facility Security Clearances) have long been available to companies that are unable or unwilling to mitigate or negate FOCI. The Proposed Rule, however, would authorize limited entity eligibility determinations generally – i.e., for cases that do not involve FOCI mitigation or negation.

What's not clear is when agencies are expected or allowed to opt for limited determinations. The Proposed Rule implies that limited eligibility determinations should be subject to the same requirements as eligibility determinations generally. We've asked ISOO to provide examples where they believe such limited eligibility determinations are appropriate. This appears to be a new authority, and agencies will need guidance on how to use it.

Make Sure FOCI Mitigation and Negation Plans Do Not Interfere with the Ability of Any Entities (including Parents and Affiliates) to Comply with Applicable Laws

The Proposed Rule states that "[a]ny mitigation or negation measures the CSA approves for an entity must not impede or interfere with the entity's ability to manage and comply with regulatory requirements imposed by other Federal agencies (such as Department of State's International Traffic in Arms Regulation)." This addresses an important concern, but under the Proposed Rule, the term "entity" refers only to the entity being processed for an eligibility determination (facility clearance). We believe it also is important that the FOCI mitigation or negation plan not interfere with the ability of the parent company or affiliates to comply with regulatory requirements imposed by law.

For example, the statutory obligation of publicly-traded companies to maintain internal controls makes no exception for companies operating under FOCI mitigation or negation plans. Moreover, whether publicly traded or not, under U.S. and foreign laws, corporate entities will be held responsible for the transgressions of their subsidiaries, and thus must ensure compliance not only with anti-corruption laws but also, by way of example, equal opportunity employment laws, whistleblower protection, environmental laws and regulations, and like matters.

In our experience, well-managed companies under FOCI mitigation and negation plans comply with organization-wide policies intended to ensure compliance with law, under the oversight of the cleared company's board-level Government Security Committee, and subject at all times to the obligation of the uncleared parent and affiliates to avoid actions that would adversely affect the performance of classified contracts or compromise the integrity of classified and controlled unclassified information.

The NISP should recognize, therefore, that mitigation or negation measures not only should not impede or interfere with the cleared entity's "ability to manage and comply with regulatory requirements imposed by other Federal agencies" but also should not impede or interfere with the ability of the entity's parents and affiliates to comply with applicable laws.

In this respect, we have also recommended that the Proposed Rule extend the same treatment (subject to the same limitations) to state and local regulatory requirements as would be accorded Federal regulatory requirements. Further, all U.S. companies, including but not limited to foreign- controlled companies, may have compliance obligations under applicable foreign laws, e.g., the UK Bribery Act 2010, which subjects commercial entities (including U.S. companies doing business in the U.K.) to sanctions for failure to prevent bribery unless they have "adequate procedures" in place to prevent such offenses.

In sum, FOCI mitigation or negation agreements should not interfere with the ability of any parties to comply with applicable law, so long as compliance would not violate U.S. law or result in unauthorized access to classified information or compromise the performance of classified contracts.

Ownership does not Necessarily Require Tougher Measures

The Proposed Rule states that "[m]itigation or negation options are different for ownership versus control or influence." We agree. But the Proposed Rule goes on to make the erroneous claim that "ownership necessitates a stronger mitigation or negation measure." [Emphasis added.] Although it is generally true that ownership encompasses control and warrants a stronger mitigation measure than "control or influence" without ownership, it is not necessarily true. For example, a foreign person may have the contractual and unilateral right to appoint senior management of a joint venture under a teaming arrangement in which they supply personnel and technology but have no ownership in the joint venture.

Since the determination respecting a mitigation or negation measure in all cases will be fact specific, we have recommended that ISOO strike the phrase "ownership necessitates a stronger mitigation or negation measure."

Voting Trust Agreements and Proxy Agreements are Not "Substantially Identical"

The Proposed Rule states that Voting Trust Agreements ("VTA") and Proxy Agreements ("PA") are "substantially identical arrangements[.]" [Emphasis added.] This is true only in the sense that both act as FOCI negation plans; not as a matter of law. The Proposed Rule acknowledges this in the sentences immediately following the quoted language: "Under the VTA, the foreign owner transfers legal title in the entity ... Under the PA, the foreign owner conveys their voting rights...." There is a significant difference between transferring legal title to an entity and transferring voting rights, which is likely why the VTA is almost never used.

We have recommended that Section 2004.34(f)(6)(iv) be amended by striking the words "substantially identical."

CSAs Should have the Authority to Waive Prior Involvement by Candidates for Trustee, Proxy Holder, and Outside Director Positions

The Proposed Rule states, without limitation, that candidates for trustee, proxy holder, and outside director positions must be "completely disinterested individuals with no prior involvement with the entity, the entities with which it is affiliated, or the foreign owner...." This language conflicts with the National Industrial Security Program Operating Manual ("NISPOM"), which states that candidates must be completely disinterested "[e]xcept as approved by the CSA in advance and in writing...." No waiver authority is included in this provision of the Proposed Rule.

The failure to include waiver authority here may be inadvertent. It is certainly ill-advised. Candidates for trustee, proxy holder, and outside director positions may have had a prior involvement with the entity that, viewed objectively, should not be disqualifying. Such determinations are fact specific. The NISPOM wisely allows the CSA to waive the prohibition (in advance and in writing). We recommended adding waiver authority.

The National Interest Determination ("NID") Process Needs Repair

The release of a revised NISP Directive provides an opportunity to correct the NID problem, which has continued to plague a large number of entities that are cleared through Special Security Agreements ("SSA"). Despite incremental improvements over time, the process remains long, opaque, and an unfair competitive disadvantage for companies operating under SSAs, to the detriment of competition and U.S. national security.

We have therefore proposed that ISOO establish criteria to provide a "presumption of NID approval" under specific circumstances. These criteria, among other things, would almost assuredly require a strong record of NISP and SSA compliance. In such cases, it is fair to presume that proscribed information can be entrusted to the entity at very low risk. Requiring all companies to go through the lengthy NID process – even when success is virtually guaranteed – is an unnecessary impediment. Establishing standards for a presumptive NID would facilitate competition and free government resources to focus on entities that do not have a lengthy history of successful compliance with the NISPOM and other U.S. laws and regulations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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