Section 818 of National Defense Authorization Act for Fiscal Year 2012  calls for DoD to implement a risk based approach to counterfeit prevention and to establish regulations for contractors to “eliminate counterfeit electronic parts from the defense supply chain”. DoD Instruction 4140.67, DoD Counterfeit Prevention Policy , describes a realistic approach to counterfeit prevention. DODI 4140.67 states it is DoD policy to “Not knowingly procure counterfeit materiel” and calls for DoD to “employ a risk based approach to reduce the frequency and impact of counterfeit material”. Furthermore, DODI 4140.67 identifies “prevention and early detection” as the “primary strategy in eliminating counterfeit materiel within the DoD”. This strategy is consistent with recommendations the defense industry has communicated to DoD on several occasions over the past few years. Rather than extending this risk based approach to contractors, however, the strategy within the proposed DFARS rule on “Detection and Avoidance of Counterfeit Electronic Parts”  seeks to address the counterfeit electronic parts threat through (a) the purchasing systems of prime and upper tier contractors; (b) DoD approval of these purchasing systems; and (c) the withholding of payments to contractors. While definitive countermeasures can be applied by contractors to manage this problem more effectively, the global nature of the supply chain and current U.S. Government policies, including requirements described within this proposed DFARS rule, continue to present significant barriers to eliminating counterfeit products from the supply chain altogether.
Here are examples of the imbalanced approach to counterfeit prevention described within the proposed DFARS rule on “Detection and Avoidance of Counterfeit Electronic Parts”:
Gaps in Counterfeit Prevention Expectations Throughout the Supply Chain
Counterfeit parts find their way into the supply chain through Independent Distributors and “Brokers”. According to GIDEP reports, the vast majority of suppliers associated with the sale of counterfeit electronic parts are Independent Distributors and brokers . The incidents included in the Senate Armed Services Committee (SASC) investigation into counterfeit electronic parts in the DoD supply chain were sold to defense contractors by Independent Distributors and “Brokers” . The proposed rule, however, fails to direct requirements toward these lower tier suppliers. The proposed rule introduces a requirement for contractors to “establish and maintain an acceptable counterfeit electronic part avoidance and detection system” as a part of the contractor’s purchasing system. “Failure to do so may result in disapproval of the purchasing system by the contracting officer and/or withholding of payments.” This new requirement, however, will apply only to contracts that are subject to the Cost Accounting Standards (CAS). In other words, the requirements will not apply to any contract less than $650,000 and will not apply to any contractor which does not have to be CAS-compliant because of its size. According to the Federal Register Notice, “DoD does not expect this proposed rule to have a significant economic impact on a substantial number of small entities … it applies only to contracts that are subject to the Cost Accounting Standards (CAS)… Contracts with small entities are exempt from CAS”. Most if not all of the suppliers associated with the sale of counterfeit electronic parts described in GIDEP reports and in the SASC report would be exempt from the requirements described in the proposed DFARS rule. Rather than also directing counterfeit prevention requirements toward lower tier suppliers who tend to be associated with the sale of suspect counterfeit electronic parts, the proposed rule focuses on prime and upper tier contractors (large entities subject to CAS) who are not as well positioned to “eliminate counterfeit electronic parts from the defense supply chain”. Prime contractors, for example, are frequently systems architects and systems integrators who may not be involved in the direct procurement of electronic components; their lower tier suppliers tend to be in a more effective position to implement counterfeit electronic part avoidance and detection practices. Many suppliers below the prime and upper tier contractors, however, are reluctant to establish and implement a counterfeit electronic part avoidance and detection system expected of prime and upper tier contractors in the proposed rule.
Absence of fundamental counterfeit prevention practices and implementation expectations
Counterfeit prevention practices recommended by industry subject matter experts, specified in industry standards, and required of DoD and its contractors per NDAA2012§818 focus on acquiring electronic parts whenever possible from the most trustworthy suppliers – the original manufacturer or its authorized distributors. DoD’s new counterfeit prevention policy, DODI 4140.67, and the proposed DFARS rule both omit this keystone to counterfeit prevention. Furthermore, the propose rule requires “Contractors’ counterfeit electronic part avoidance and detection systems” to include “Use and qualification of trusted suppliers”, but does not define the term “trusted supplier” or describe expectations or criteria for “use and qualification”. DODI 4140.67 uses a different and vaguely defined term – “qualified supplier”. According to DODI 4140.67, ASD(R&E) has been tasked with the responsibility to “[collaborate] with DoD Components to establish technical anti-counterfeit qualification criteria for suppliers”, but there are no expectation of contractors described within DODI 4140.67 and the proposed rule exempts smaller suppliers (including electronic part suppliers) from counterfeit electronic part avoidance and detection requirements to be defined at a future date by ASD(R&E).
“Incentives” for contractors based on inaccurate assumptions of cost recovery
The requirements of the proposed rule concerning unallowable costs are based on the assumption of Senate Armed Services Committee (SASC) that contractors already recover costs associated with counterfeit part quality escapes from its suppliers. In the report of its investigation into counterfeit electronic parts in the DoD supply chain , SASC asserts that the requirement concerning unallowable costs is intended to “strengthen incentives for contractor adoption of aggressive counterfeit avoidance and detection programs and align DOD contracts with best practices in the commercial sector”. The report refers to examples of DoD contractor standard terms and conditions as rationale to assert that “Government contracts that permit cost recovery in such circumstances also contrast with agreements contractors enter with their own suppliers.” The report and the proposed rule do not acknowledge realities that a DoD contractor faces.
The proposed rule inaccurately presumes (1) lower level suppliers universally accept counterfeit prevention flow downs, and (2) contractors generally recover all costs from its suppliers who supplied counterfeit or suspect counterfeit parts or supplied items containing counterfeit or suspect counterfeit parts. To further complicate matters, smaller suppliers (including electronic part suppliers) who, according to the proposed rule, will be exempt from counterfeit electronic part avoidance and detection requirements are not adequately capitalized to be able to hold harmless and indemnify prime and upper tier contractors for costs that cannot be recovered from their customers under NDAA2012§818.
In order to establish a more balanced DFARS rule on “Detection and Avoidance of Counterfeit Electronic Parts”, DoD should (1) impose a requirement for counterfeit electronic part avoidance and detection systems on contracts and contractors at all tiers, (2) exclude electronic part purchases from small business set asides, and (3) include specific criteria for “counterfeit electronic part avoidance and detection systems” including the central tenets of counterfeit electronic parts prevention .
 H.R.1540: National Defense Authorization Act For Fiscal Year 2012, Public Law No: 112-081
 DoD Instruction 4140.67, DoD Counterfeit Prevention Policy (April 26, 2013)
 Proposed DFARS Rule on “Detection and Avoidance of Counterfeit Electronic Parts” (Docket Number 2013-11400)
 Livingston, H., “Avoiding Counterfeit Electronic Components – Part 2: Observations from Recent Counterfeit Detection Experiences”, May 2007.
Livingston, H., “Observations from Counterfeit Cases Reported Through the Government–Industry Data Exchange Program (GIDEP)”, September 2011.
 “U.S. Senate Armed Services Committee Hearing to receive testimony on the Committee’s investigation into counterfeit electronic parts in the Department of Defense supply chain”, Nov 2011
 Livingston, H., “Compliance Programs for Counterfeit Parts Avoidance and Detection”, Contract Management, National Contract Management Association, May 2013