Anti-counterfeit regulation (and the pressure on distributors) is intensifying

The comment period for the proposed revisions to the Defense Federal Acquisition Regulation System (DFARS) ended on July 15, 2013. This important piece of legislation, which is expected to go into effect in the first quarter of 2014, is the culmination of several years of effort by lawmakers to deal with the problem of counterfeit electronic components. And while the impetus for the regulation was defective military components which endangered soldiers and weapons systems, the legislation is having a ripple effect across the entire electronics supply chain. The Department of Defense (DoD) proposed to revise the DFARS to partially implement Section 818 of the National Defense Authorization Act (NDAA) for Fiscal Year 2012, which holds suppliers and distributors responsible for counterfeit parts and has generated intense interest among electronic industry groups, leading to some modifications. A positive outcome, however, of the discussions surrounding the new legislation is the fact that it helped to expose the longstanding issue of counterfeit components and its negative impact across the entire supply chain.

How did we get here?
In order to understand the momentum behind anti-counterfeit regulation in the US, it helps to trace efforts back to the initial legislation which followed November 2011 Senate hearings on the danger counterfeits pose to the military supply chain.

• In December 2011, President Obama signed the 2012 NDAA which, for the first time, detailed penalties related to counterfeit parts and their suppliers. The NDAA was a reaction to then-recently publicized incidents of expensive and possibly life-threatening failures of military weapons and transportations systems caused by counterfeit electronic components. In the NDAA, the burden was placed on military contractors to more effectively prevent counterfeits from entering the supply chain or risk financial, and possibly criminal, penalties. The immediate industry response was that regulation had gone too far, and that the prevention of counterfeits required a more balanced approach.

• On January 2, 2013, President Obama signed the 2013 NDAA which, in a rare display of bipartisanship, had been overwhelmingly passed in both the Senate (98 yes votes to 0 no votes) and House of Representatives (299 yes votes to 120 no votes). The 2013 NDAA attempts to remedy what many in the electronics industry had considered knee-jerk and extreme regulations in the 2012 NDAA.

• The 2013 NDAA includes a revised set of regulations, requiring contractors to demonstrate “an operational system to detect and avoid counterfeit parts and suspect counterfeit parts that has been reviewed and approved” by the DoD in order to avoid complete liability for replacing counterfeit parts, an expense which could run into the billions of dollars. This regulation puts the onus on contractors to include safeguards in their systems or risk being held financially responsible for any counterfeits that make their way into military projects. The Department of Defense has been tasked with sharing accountability for counterfeits with contractors, as long as that contractor agrees to source parts only from original manufacturers or their authorized distributors. It is considered an improvement and a more balanced approach over the 2012 NDAA which somewhat unrealistically placed all responsibility on the contractor.

• In March 2013 the DoD updated the Defense Federal Acquisition Regulation (DFAR) Supplement to the Federal Acquisition Regulation (FAR). The updates are part of measures intended to regulate the detection and avoidance of counterfeit electronic parts. A portion of the NDAA regulations specifically spells out new requirements for analyzing, assessing and acting on reports of counterfeit electronic parts. In order to encourage the reporting of counterfeits, which has lagged due to fear of liability among companies, the NDAA specifically protects procurements professionals and their companies from civil liability. This underscores the increased emphasis on reporting as another tool in the fight against counterfeits.

· In May 2013, the DoD released its proposed revisions to the Defense Federal Acquisition Regulation System (DFARS). The revisions focus on defining a ‘legally authorized source’ as “the current design activity or the original manufacturer or a supplier authorized by the current design activity or the original manufacturer to produce an item [emphasis added]”. ‘Authorized distributors’ do not appear as a term in the proposed revisions but may be considered to be included by virtue of the terminology highlighted above. As the supply chain becomes more complex, factory-to-end user transactions have become the exception rather than the norm. A key revision would ensure that purchase orders and subcontracts contain flow-down clauses that impact the component manufacturers and their distributors. This truly expands accountability not only with the government contractor, but all the way up the supply chain to the manufacturer, making direct traceability vital. The comment period for these proposed revisions ended on July 15, 2013.

With the legislation likely to take effect in early 2014, franchised and authorized distributors of electronic components are in a strong position to offer a solution to the uncertainty surrounding counterfeit components and the responsibility on the individual. By ensuring 100% direct traceability to the original manufacturer, these distributors’ business models already incorporate many of the safeguards the anti-counterfeit legislation requires. In addition, these safeguards are in place for all buyers, not only the military-related supply chains that are the direct beneficiaries of the new regulations. All buyers that purchase electronic components from franchised and authorized distributors can be confident that they are receiving legitimate parts with direct traceability back to the original manufacturer, a guarantee that has been in place prior to the above regulation, and will continue regardless of any future changes in the law.