Interview transcript
Terry Gerton The President’s executive order from January 7 that focused on addressing underperforming defense contractors has certainly generated a lot of interest over the past few weeks. What’s the latest that you’re hearing on the legal front?
Chris Griesedieck Well, the most recent development that I saw actually came out of the Davos Forum just a couple of days ago. Treasury Secretary Scott Bessent was there and he was asked about this executive order and he said, in terms of the defense primes, they’re no different from systemically important banks and they exist at the pleasure of the United States of America to serve our national defense and they failed. Those are his words, and he thinks that many of them are five to seven years behind and their deliveries. And he thinks that this new executive order, the restrictions that are in it, should be in place for two to three years or as long as it takes to reach some normalized level of backlog, is the term that he used. So it does seem like this is being taken seriously across the administration.
Terry Gerton Well, there are some terms in this executive order that would benefit from some clarity, things like underperforming contractor, large contractor, even defense contractor. How do you understand those terms being applied?
Chris Griesedieck Yeah, that’s a great question. Right now, we don’t have guidance on both the undefined standards and the undefined application. So we don’t know exactly which contractors for the Department of War or the Department of Defense, whichever term you want to use these days, are going to be subject to this. It seems initially focused on the larger prime contractors who focus on weapons systems, at least initially. But moving forward, we don’t know whether or not there will be exemptions for producers of commercial items, for example. We don’t know whether or not service providers as opposed to manufacturers might be exempt or whether or small businesses could be exempt from portions of this executive order or non-traditional defense contractors. And then to your point, the standards for what it means to be underperforming or to not be investing sufficient capital in capacity or to not be prioritizing government contracts, those are all undefined as well. So one would hope we’ll get the guidance moving forward with more objective criteria, but there’s the risk that it could be more subjective and we’ll just have to see how it’s gonna be implemented.
Terry Gerton Acquisition of major defense weapons systems is a really complicated space, and the federal government has some responsibility here as well, I would think. The government has been known to change its requirements, to change its funding strategy, to change its acquisition strategy in the middle of a buy. How does this executive order assign responsibility, and will the defense contractors have a chance to make their argument that, hey, this wasn’t our fault.
Chris Griesedieck The contractor is supposed to have a chance to make their case, but the fact that it wasn’t their fault is not expressly listed as one of the considerations. The executive order does say that the secretary of war or defense is going to consider whether to initiate any enforcement action and take into account certain things, such as the financial condition of the contractor or the economic viability of relevant programs. But the extent to which the government might itself be at fault or partially to blame for the issue is not listed, although I agree with you, it seems to me that would be relevant. And then, you know, thinking through things a little bit more, if you look at the executive order, it says that it has to be implemented in accordance with existing law, right? And so, one would think that if one of the mechanisms for enforcement here is going to be what’s already in the Federal Acquisition Regulation or the Defense FAR Supplement, such as terminating a contract for default — you can’t terminate a contractor for default if it was the government’s fault, whatever the underlying issue was, right? The contractor could sue and seek to have that T for D converted into a termination for convenience instead. So you know. Whether or not the government had some hand in the issue that led to the government thinking that there needed to be remediation, it would be relevant to the enforcement action that could be brought in relation to this executive order, even though the executive order doesn’t really talk about it expressly.
Terry Gerton I’m speaking with Chris Griesedieck, he’s a partner with Venable. So let’s go back to the structure of these companies, because many of the major primes and even the mid-tier defense contractors have diversified portfolios. Defense may not be their own business. So how will this EO affect companies whose defense business is only part of their surprise.
Chris Griesedieck Yeah, I think that’s probably the biggest concern. And, you know, we mentioned before Secretary Bessent’s statement that these defense primes existed at the pleasure of the United States of America. That’s not really true for a lot of these companies who serve the Department of Defense these days. A lot of them are primarily commercial providers. And in fact, this administration has really placed a bigger emphasis on trying to buy commercially where possible. And so I think it would come as a surprise to a lot of commercial providers that the government wants to get involved in sort of core corporate governance matters, such as how CEOs are paid, what their compensation structure looks like, whether or not you’re going to be able to be involved in a stock buyback or corporate dividend. Those are all the sorts of things that I think commercial providers are not used to the government having a hand in, at least not in the way that’s contemplated here. So that would be new, and I think it should cause anybody considering getting into the government contract space for the first time, or at least the defense contracting space, it should give them maybe not pause, but they should really consider, do I want to get in this space, and what’s it going to mean for me?
Terry Gerton One of the other angles I think that’s interesting here is that many of the U.S. defense primes also sell to other countries, right? They may sell to our allies, they may be part of foreign military sales. How is that going to get factored into these considerations?
Chris Griesedieck So that’s one of the hammers that is potentially going to be brought to bear according to the executive order. If a contractor is identified for remediation, which the executive order basically says that if you’ve done a stock buyback or a corporate dividend or distribution during a period of time where the secretary of war finds that you have been underperforming or not investing sufficient capital, etc., then you’re gonna get somebody who’s gonna come to you and say, we need to do something about this. And that something could potentially be, you know, a negative performance rating, or it could be a termination or the government not opting to renew the contract, but it could other things too. And one of them that’s expressly invoked is this idea that the government might not support you when it comes to a direct commercial sale or a foreign military sale. And those, for people who don’t really deal in that world a lot. You’re right, they’re basically selling defense materials to foreign governments. The two work a little bit differently. One of them is a direct transaction with that foreign government that is approved in some way by the Department of State and others in the government, or the other one, an FMS sale, is where DoD is more like an intermediary for it. But your support and approval to move forward with those could be in jeopardy as a result of this executive order. That’s the basic narrative that needs to come out of this. And people need to consider that. And if you look at the FMS market and DCS as well, it’s a lot of money. It’s hundreds of billions of dollars. And so people’s ears should be perking up, I think, to hear that that could be invoked.
Terry Gerton So the EO doesn’t tell us specifically how DoD is going to evaluate companies and what that process is going to look like, but eventually, somehow someone is gonna get notified that they’re an underperforming defense company. What happens next in the process?
Chris Griesedieck So the EO says you’re supposed to get notice, and then you basically get 15 days to try to resolve it with the Department of Defense. And that might include submitting a remediation plan that’s been approved by the board of directors for your company. And perhaps the reference to a board in there suggests the kind of entities that are being targeted, at least initially, large companies that have a board of director as opposed to other entities that don’t. And then, if you don’t resolve it within that 15-day period, you know, that’s when the enforcement could start happening. And so I think that’s another thing that people really need to be considering now is if you feel like you could potentially get on this list, particularly if you are a manufacturer of critical weapons and you’re a prime contractor for the DoD, you should be doing a review right now of your contracts to determine, is there going to be an allegation that we’re underperforming or that we are not investing sufficient capital in some way in the overall defense capacity of the country or in production facilities. And if you feel like you might be targeted for one of these remediation efforts, you should be looking at your buyback history and your distribution history and your executive pay packages to see whether or not they are compliant with what the expectations may be moving forward.
Terry Gerton That’s really helpful. And I’d like to dig in a little bit more to what these boards and compliance teams should be looking at. Presumably all of these things have been reported and provided in routine filings. If you’re part of the compliance team or the board that’s worried about audits and SEC filings and those kinds of things, what should you be thinking about specifically? And if you think you’re okay, Should you be engaging with DoD early?
Chris Griesedieck Yeah. So taking your first question first there, you know, I think that it would make sense to really kind of integrate the teams a little bit in terms of those who are thinking about SEC filings and corporate disclosures and things like that. And those who were a part of the core contracting side of things and really be thinking through what are our major programs that could subject us to review and scrutiny here and how are doing on them, you know? And if we think that there might be an issue, let’s proactively think through what are the most likely ways in which enforcement would happen. Are we somebody who is deeply involved in the DCS or the FMS world? Do we think we are likely to get dinged based on the pay structure that we have in place for our corporate executives, for the C-suite? We know that one of the things in the executive order that they’re going to be looking at is to put a new clause into contracts moving forward saying that that pay structure should not be focused on short-term rewards like EPS and it should be focused on on-time delivery and doing a good job for the government. And even if you’re not going to be targeted, you don’t think. If this clause is going to put into contracts in the near future, you’re going to have to comply with it potentially. We don’t know exactly which contracts it’s going to go into. That’s one of the most interesting parts of the executive order to me, is that this clause, it says any defense contract. It’s not limited to critical weapons systems. And so taking that at face value, it could be very broad. And so you could see a lot of people who are gonna have to think through, do I really wanna bid on this new defense contract, given how we currently operate internally? And if not, you need to plan ahead for it.