Live Long and Prosper

How one former federal organization is adjusting to life after government

f the Patent and Trademark Office is the prototypical performance-based organization, then Phil Harper may just be the role model for the "public" executive of the future. He is the man in charge of one of government's most sensitive core functions: intrusive, no-stone-unturned investigations into the private, personal histories of prospective federal job holders. By all accounts, Harper does his job very well. But he is not a federal employee; rather, he is one of the most recent, and most unusual, members of what the University of Wisconsin's Donald Kettl calls the "proxy government." Harper is president and CEO of U.S. Investigations Services Inc. (USIS).

Until July 1996, USIS was the Office of Federal Investigations in the Office of Personnel Management. Then OPM Director James B. King privatized the operation. Now it is an employee-owned firm (owned by former federal civil servants) that has become the largest private investigations company in North America.

Employee-owned enterprises have operated in the United States for more than a century (there are more than 3,000 today), and their ranks include some household names like United Airlines and Avis. However, by all accounts, USIS is the first ever to involve a former federal agency. Each one of USIS' employee-stockholders holds one or more shares in the company. Those shares are the basis for the company's primary pension plan (the company also provides a 401(k) plan for its workers) and depending on the company's profits, they-and hence, the retirement plan-appreciate in value. Thus, the net worth of those shares (they are valued by an independent auditor) represents the employee's equity stake in the investigations enterprise.

An Elegant Solution

That equity stake is what makes an employee stock ownership plan (ESOP) so intriguing as a reinvention option. In 1995, shortly after the National Performance Review asked agencies to consider privatization alternatives, King and his OPM staff thought of the Office of Investigations, and they began to explore the possibility of an employee stock ownership arrangement. To King and company, such an approach offered an elegant solution, privatization without pain, a way to soften employees' expected and understandable resistance by giving them a real financial stake in the outcome.

As a first step, OPM contracted with ESOP Advisors Inc. to conduct a feasibility study (employees had to obtain special waivers from OPM's ethics lawyers just to be able to participate), and by the fall of 1996, they had concluded that an employee-owned investigations business was indeed viable. With that study in hand, OPM chose American Capital Strategies (ACS) to develop a business plan. ACS in turn found a financial trustee (Marine Midland Bank of New York) and together with the law firm Arnold and Porter, they began to recruit a management team.

Congress of course had something to say in the matter. As the matter was taken up on Capitol Hill, Sen. Paul Simon, D-Ill., opined that privatization of background investigations "could lead to real mischief and abuse." However, this turned out to be a case where practice had already outpaced policy. During 1996 hearings before the House Government Reform and Oversight Subcommittee on the Civil Service, a parade of witnesses excoriated King for attempting to privatize investigations. They were followed by a Drug Enforcement Administration official, who conceded that private firms had been conducting background checks of DEA's law enforcement officers for years without apparent adverse effect. The subcommittee eventually declined to interfere with OPM's plan, but its staff remains skeptical of the idea of privatized investigations.

Divestiture and Incorporation

Eventually, Harper, a decorated former Army officer with 20 years' experience in the private security business, and two other key executives were brought on board to help form what was to become USIS Inc. The company was incorporated in Delaware in April 1996 with a single share and a single employee-Phil Harper. It was reincorporated in August 1996, hiring almost 700 former Office of Federal Investigations employees on the Saturday following their Friday separation from federal service.

USIS continues to operate under something of a public policy cloud. There are those who contend that its business, like that of the Patent and Trademark Office, is inherently governmental and should only be performed by civil servants. Harper is quick to respond. "Every subject has given us written permission to conduct a background investigation. Moreover, all we do is collect the data and turn it over to an agency. That agency makes the final decision on the candidate's suitability." According to Richard Ferris, a former investigator who now heads OPM's oversight of USIS, it also helps that he and his staff are dealing with former colleagues with years of federal service. "Deep down, these are still federal employees who haven't forgotten what it means to have the public's trust," he says.

Shields Up!

Ferris, however, concedes that "some worry about the next generation of investigators. Will they treat their responsibilities as seriously?" As an added insurance policy, OPM has established elaborate contractual safeguards to insure accountability. "Our agreement contains all sorts of quality, quantity and timeliness standards, and we're very serious about enforcing them," says Ferris.

Harper characterizes OPM as the "gatekeeper for access to the results of our investigations-and that means even more protection." OPM and USIS are also serious about customer satisfaction-both regularly survey federal agencies to make sure they are getting what they want. Some agencies, such as the Immigration and Naturalization Service and the Treasury Department, started out as skeptics, according to company officials, but are happy now. USIS wants to keep them that way.

These are not academic exercises; rather, customer satisfaction is truly a matter of survival for USIS. The company knows it "can't end up with a product that no one wants to buy," says Harper. "Once your reputation goes down, so too do the prospects for growth." And growth is critical to meeting the company's contractual commitments. Its agreement with OPM requires USIS to reduce its "unit price" each year, on the assumption that it will be able to offset some of its fixed costs by expanding its business base of private and non-federal customers. OPM also expects the company to take advantage of some of the management flexibilities (in personnel staffing, procurement, financial management, etc.) denied to federal agencies.

So far, the fledgling company has managed to make it through the political asteroid belt without incident, and today, its 700 employee-shareholders own about 91 percent of a company valued at $28.2 million. Harper and the other 11 company officers, who together put up an initial seven-figure investment, hold the remaining shares. Under the terms of its corporate charter, USIS is governed by a nine-member board of directors. The board's five "inside" members include Harper and two others elected by employees; the three of them in turn nominate the two remaining members. However, as with most private companies, the board's role is limited. It does not run USIS-that's Harper's job, along with his immediate staff-instead concerning itself strictly with "ownership issues" like oversight. For example, it ensures that company resources are allocated in the best interests of employee shareholders, and it also approves key strategic decisions.

Happy Birthday

Of course, such issues are made easy when you begin a business with the federal government as a guaranteed customer. Indeed, for all practical purposes, USIS has no competitors, a fact underscored-some critics would say exacerbated-by OPM's decision to give the company a noncompetitive three-year contract as a birthday present.

According to Ferris, there were some compelling practical reasons for OPM's decision. Most important was the matter of capacity. Even as OPM got out of the investigations business, it wanted to ensure a seamless, transparent transition for its former federal customers, and it could not guarantee that with any of the existing firms in the marketplace.

For example, when USIS was initially established, its closest rival was a certain $12 million private investigation firm, but all but $1.5 million of that firm's background check business involved security guards and custodial staff-work that was nowhere near the complexity and sophistication required by federal agencies. Contracting with that firm, or even a consortium of existing private firms, would have raised serious capacity and quality issues. Harper is more blunt: "The Immigration and Naturalization Service just finished hiring several thousand new border control agents, and someone had to do their background checks. We were the only ones with the capacity. If it had been anyone else, INS would not have been able to get the people it needed."

Then there was the matter of employee acceptance. A guaranteed, sole-source contract-providing at least a measure of employment security for former feds-seemed the course of least resistance. However, there were surprises along the way. Harper was on the receiving end of some of them.

"When I first met with our prospective employees, they really beat me up. I thought I was saving their jobs; they thought I was the devil." However, after many bruising meetings with the OPM investigative staff, employees gradually came to accept what was happening.

"One of our biggest enemies was lack of knowledge," Ferris says. "No one understood what an ESOP was, for example. Once people began to get educated, they realized that it could actually work out better for them in the long run."

The Bottom Line

Early returns are encouraging. According to Harper, "USIS is doing 40 percent more work-in part because of the Immigration Service's current hiring surge-and we're doing it with 10 percent fewer employees. We've also reduced our turnaround time by three days."

As a result, the case backlog that Harper inherited has virtually disappeared, and he expects further improvement as the company expands its business base.

O.B. Seaton, USIS vice president for marketing and business development, agrees: "Federal agencies, especially those that didn't use OPM before, as well as state and local governments, are finding that it's more economical to outsource background investigations, so long as the quality is there."

Things seem to be going well from an employee perspective as well. Most importantly, they all have jobs.

Some 90 percent of those who worked in the old Office of Investigations are now employed by USIS. (No one was involuntarily separated-the other 10 percent either stayed as part of OPM's oversight staff, transferred to another agency, or retired.) And USIS offered them all base salaries that matched the pay they received in government; in fact, 75 employees actually received raises.

Automatic "step increases" in salary, however, are history. Health benefits and leave entitlements-developed in conjunction with the employee liaison committee before the company was even started-appear to be comparable with federal benefits, although as non-federal employees, USIS workers pay their share of health insurance premiums on a more advantageous pretax basis.

Retirement, of course, is another matter-after all, this is an ESOP, and the ESOP is what underwrites most of the employees' retirement benefits. USIS had agreed to contribute at least 7.5 percent of share value (in effect, the assessed value of the company) to its ESOP fund, but this year, because of better-than-expected earnings, it actually contributed more than 10 percent. That translates into greater equity for employees now-and better pension benefits when they retire.

Warp Drive

Still, the pressure is on to deliver. USIS is approaching its first birthday, and that means it has just two years to go before its contract with OPM is reopened. "Three years is not a very long time to start a company from scratch," says Harper, "We argued strongly for a five-year contract to give us more breathing room, but OPM wouldn't budge."

Nevertheless, Harper feels the company is actually ahead of schedule in its transformation from federal agency to entrepreneurial company. He is already thinking beyond the initial transition period.

Harper currently works under a five-year contract, and like all good CEOs, he has started to worry about leadership continuity. "My plan," he says, "is to train a former fed to be my successor, but the several who are in the pool need some additional skills and experience before they're ready."

Harper isn't talking about investigations skills. He knows that the people who work for him already know how to do investigations. He wants them to develop business skills. To accomplish that, the USIS CEO has been sending his top executives to places like the Wharton School at the University of Pennsylvania.