DOW Announces Review Of All Small Business Set-Aside Contracts Over $20 Million

Highlights

• U.S. Department of War (DOW) Secretary Pete Hegseth announced that line-by-line reviews will be conducted for all DOW 8(a) sole-source contracts of more than $20 million and all small business set-aside awards over the same amount.
• Secretary Hegseth said his goals for the reviews were to get rid of contracts that don't "help win wars" and eliminate pass-through schemes.
• This Holland & Knight alert examines the DOW's planned reviews and identifies steps affected contractors should be taking.

U.S. Department of War (DOW) Secretary Pete Hegseth on January 16, 2026, posted a video on social media calling for a line-by-line review of DOW 8(a) sole-source contracts of more than $20 million. The secretary stated his goals were to get rid of contracts that don't "help win wars" and do away with pass-through schemes.

The secretary noted that the 8(a) Program's goals of assisting small, disadvantaged individuals and Tribes were "laudable." However, he went on to state that the 8(a) Program has morphed into "swamp code word" for diversity, equity and inclusion (DEI) race-based contracting and claimed that in many instances, small, disadvantaged businesses don't do any work and simply put a fee on top and pass the work on to "large consulting firms," which he characterized as "beltway bandits." From there, the secretary emphasized that "lethality" was the DOW's driving objective, that "contracts that don't help win wars are gone" and that the DOW would be doing away with pass-through schemes.

On January 21, 2026, Secretary Hegseth issued a memorandum (dated January 16, 2026, but apparently not immediately released) that substantially expanded the coverage of his video announcement. Citing that the DOW's 8(a) spending is nearly 10 times that of any other agency, the memorandum positions the reviews as a necessary and an "above and beyond" measure to ensure taxpayer funds support legitimate small businesses and the defense industrial base, rather than "illegal pass-through schemes." The memorandum cited similar reviews by the U.S. Small Business Administration (SBA) and U.S. Department of the Treasury and notes the DOW review is authorized under Executive Order 14265, "Modernizing Defense Acquisitions," and intended to align with the cost-efficiency goals of Executive Order 14222, which launched the Department of Government Efficiency (DOGE). The memorandum also provides additional detail on the DOW's plans and a schedule for implementation.

First, the memorandum expands the review from 8(a) sole-source awards over $20 million, a relatively small universe of contracts, to now include:

• all 8(a) set-aside awards over $20 million (i.e., competitive 8(a))
• all small business set-aside awards over $20 million; the memo directs the agency to specify set-asides

This latter designation appears to take aim at not only small business set-asides, but all SBA set-aside types (HUBZone, Service-Disabled Veteran and Women-Owned small business), meaning all set-aside contracts over $20 million (i.e., "covered contracts") will be subject to the review. Consistent with the video, the memorandum states that the DOW plans to undertake a two-step review:

• Phase 1 – Mission-Alignment Review. Each DOW component must prepare a list of all contract awards that meet the criteria above by January 31, 2026. An assistant secretary, a senior executive service civilian or military equivalent must then assess whether each contract is "necessary for mission" and "critical" to the DOW's warfighting capabilities. Any contract deemed nonessential is to be terminated for convenience to the maximum extent permitted by law.
• Phase 2 – Subcontracting Compliance Audit. The memorandum directs a secondary review, to be completed by February 28, 2026, of all covered contracts to determine if Limitation on Subcontracting (LOS) requirements are being met. Reviewers are instructed to use contractor invoices, Contracting Officer's Representative (COR) logs, personnel confirmations and contract deliverables to confirm that the prime contractor is performing the substantive work. As part of this phase, officials must also confirm that contracts are performed "at or below market rates." The memorandum mandates that any evidence of "improper subcontracting" or "excessive pass-through charges" be referred to the DOW and SBA inspectors general. Those bodies may then refer matters to the U.S. Department of Justice for investigation. This elevates the risk for contractors from a contract dispute to a potential fraud investigation under statutes such as the civil False Claims Act.

By the February 28 deadline, DOW Components must deliver a detailed report to DOW leadership, including lists of terminated contracts, contracts exceeding subcontracting limits and updated fiscal year 2027 budgets reflecting cost savings.

Absent from the memorandum is any express criteria to determine terms such as "mission alignment" and "market rate." The memorandum also does not mention "large consulting firms" or "beltway bandits" highlighted in the January 16 video. However, it is clear the DOW will be focused on "pass-through" contracts, and the reference to reviewing for contracts "at or below market rates" suggests the focus may be on service contracts, which encompass consulting contracts. It is also worth noting that the current administration has targeted large consulting firms previously, including identifying 19 such firms by name in February and April 2025 and terminating tens of billions of dollars of their contracts.

In addition, the focus on LOS should not come as a surprise and, in the view of many, is long overdue. The LOS requirements are in place to benefit small businesses by ensuring they retain the bulk of the revenue from set-aside contracts. Responsible small businesses of all types have long maintained internal policies and controls to meet and document compliance with LOS. Until only very recently, SBA and contracting agencies took a pass-the-buck approach to monitoring LOS compliance, with each expecting the other to take the lead. The DOW's announcement and similar reviews being conducted by the SBA and Treasury Department represent a shift in that long-standing policy and practice. Provided these reviews are carried out in an objective and good faith manner, the integrity of the small business procurement programs will stand on surer footing and legitimate, responsible small businesses of all types will benefit.

Impact Assessment

For contractors holding 8(a) or other small business set-aside awards over $20 million, the immediate impact is a significant and urgent compliance burden. The memo authorizes contracting officers to request detailed documentation, including staffing logs and payment records, to verify performance. Companies will need to quickly assemble records to prove they are meeting subcontracting limitations and that their pricing is at or below market rates. The risk of termination is twofold: first for contracts deemed not "critical" to the warfighting mission, and second for noncompliance with subcontracting and pricing rules.

Larger defense contractors, who often serve as subcontractors to small business primes, will also be affected. While some may face disruption to existing partnerships, others could see new opportunities if contracts are terminated and recompeted without a set-aside designation. By contrast, attempts to move work away from small business set-asides might violate the long-standing "Rule of Two," which requires set-asides to be used when two or more qualified small businesses are available to perform at a fair market price.

DOW acquisition offices face a similarly intense challenge as they must identify, review and report on hundreds of high-value contracts within a matter of weeks. The deadlines of January 31, 2026, for the initial review and February 28, 2026, for the detailed compliance audit create immense pressure. These offices must develop and apply consistent standards for abstract criteria such as "mission necessity" while simultaneously conducting detailed forensic accounting of contractor performance, all under the threat of scrutiny from DOW leadership. Moreover, there is increased potential for disputes and litigation arising from widespread contract terminations, which will cause further disruption for both contractors and the DOW.

Practical Considerations for Contractors and the Government

This initiative is the latest in the wake of allegations of fraud in the SBA's 8(a) Program, including in letters sent by Sen. Joni Ernst (R-Iowa) to 22 cabinet agency secretaries in December 2025. Despite the fact that virtually all of Sen. Ernst's allegations were immediately debunked, oversight of the 8(a) Program continues. The DOW's announcement substantially widens the oversight agenda to include all small business set-aside categories. All small business contractors should be prepared for this increase in acquisition oversight, potentially leading to contract terminations and allegations of violations of LOS and other SBA eligibility requirements. For contractors holding contracts covered by the DOW's review, the following immediate actions are recommended:

• Internal Review. Immediately review all sole-source and set-aside contracts over $20 million to assess compliance with subcontracting limitations and confirm the basis for fair market pricing, particularly with respect to labor rates. If you have concerns about compliance, engage experienced legal counsel. Many of the SBA regulations, including in particular the LOS requirements, are remarkably complex and nuanced.
• Information Assembly. Proactively gather all performance documentation, including invoices, labor reports, COR correspondence and technical deliverables, as specified in the memorandum, along with other information necessary to demonstrate compliance with the LOS requirements of your set-aside contracts. Notably, the data set called out in the memorandum is not necessarily sufficient to determine LOS compliance. Much of the necessary information resides with the contractor. Therefore, small businesses should proactively gather subcontracting information, including financial information, and be prepared to proactively demonstrate LOS compliance.
• Mission-Critical Justification. Begin to develop a position on how their contracts are critical to the DOW's warfighting capabilities, research and development, or industrial base. Also review your contracts for any statutory authority mandating the program they support. Finally, help your customer determine whether it truly can carry on without the support provided under your contract and, if not, whether termination would entail substantial re-procurement costs for the agency.
• Stakeholder Engagement. Proactively open a dialogue with the relevant contracting officer and, for 8(a) firms, your SBA business opportunity specialist, to ensure alignment and address any questions before they become formal concerns.
• Contract Terminations. If your contract is terminated for convenience, know your rights. Contractors can often recover substantial amounts with a well-crafted termination settlement proposal, a topic Holland & Knight has covered in previous blogs and webinars.
• Future Requirements. If your set-aside contract is terminated or not extended, keep an eye on whether the agency attempts to re-procure the requirement on a non-set-aside basis. This may be protestable under the Rule of Two or other legal authority, including SBA regulations.
• Contractor Compliance Programs. It is now more important than ever for small businesses to assess whether their government contractor compliance programs are up to date and sufficiently comprehensive. Given the increased scrutiny over SBA programs and small business contractors, now is not the time to cut back on compliance. Even well-intentioned contractors may face significant consequences when internal controls, documentation and compliance are not aligned with current requirements. Ensuring compliance with recent policy and regulatory updates is crucial and could mean the difference between an active or terminated contract, as well as a contractor's eligibility for future awards. Strong compliance programs also help contractors identify and remediate issues early, reduce performance and payment risks, and demonstrate responsibility and integrity to contracting officers and auditors.

Conclusion

DOW contractors should act now to marshal documentation, validate LOS compliance and articulate mission‑critical justifications. In the event of contract terminations, contractors should be prepared to pursue compensation through termination settlement proposals and consider protest options should the DOW (or other agencies) seek to re-procure requirements through non-set-aside vehicles. Please feel free to contact us if you require assistance.

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.