The Boeing Co. [BA] drew plaudits from key senators for its ethics reform moves in the wake of controversies involving the Evolved Expendable Launch Vehicle (EELV) program and other issues.

One of the related issues touched on the Exoatmospheric Kill Vehicle (EKV) program.

In a hearing of the Senate Armed Services Committee (SASC), Sens. John Warner (R-Va.), the SASC chairman, and John McCain of Arizona, a high-ranking SASC Republican, both praised Boeing for paying $615 million to settle the controversies in a deal worked out with the Department of Justice (DOJ).

As well, the senators lauded Boeing for voluntarily deciding to forgo taking a tax deduction on the major portion of that payment. This move on taxes apparently cost Boeing a huge chunk of money, perhaps roughly in the area of $200 million if the tax break might be calculated using the corporate tax rate, or all of the $615 million payment.

The reform moves are the handiwork of James McNerney, who last year took the reins as Boeing chairman, president and CEO, vowing to clean house and institute tough ethics reforms in the second-largest contractor. McNerney, as a witness before the SASC, said Boeing takes responsibility for its ethical lapses, and has launched a major campaign to instill ethical values among its employees.

Warner lauded McNerney for a “very forthright” statement. Warner especially praised the Boeing decision to forego a tax cut as “a sound decision,” made “to restore its reputation.”

Warner said the investigation of Boeing controversies, and the settlement deal, will serve as a wake-up call for the entire community of contractors. This “will serve as a model for all of America’s” industrial base of contractors, acting to “shore up business ethics and conduct,” Warner predicted.

McCain said he was extremely encouraged by the Boeing decision to give up deducting the penalty and compensatory payment from its taxes, saying that “actions speak louder than words.”

This decision by McNerney shows how serious Boeing is about reform, McCain said.

But McCain said he is concerned that the Department of Justice negotiated an agreement where tax deductibility might have been possible.

McCain said it might be time for Congress to prohibit any wrongdoer from recovering costs of settlement agreements from any third party, including taxpayers and the government.

The settlement agreement with the government covered Boeing hiring an employee who transferred from a competitor. The worker brought to Boeing bid-sensitive documents of his former employer, Lockheed Martin Corp. [LMT], relating to the EELV program.

Deputy Attorney General Paul McNulty and other DOJ aides gave the SASC a close-up view of how the launch documents scandal unfolded.

He said the worker, Kenneth Branch, was hired by a Boeing staffer, William Erskine. In June 1999, “another Boeing employee reported to Boeing management that Erskine had hired Branch in return for Branch providing Erskine with Lockheed documents pertinent to Lockheed’s EELV proposal.”

When Boeing higher-ups discovered this, they reacted swiftly.

“Boeing conducted an internal investigation and, in August 1999, terminated Branch and Erskine. Boeing also informed Lockheed and the Air Force that it had certain documents proprietary to Lockheed in its possession.”

With that sort of corrective response, it might be puzzling as to how Boeing wound up in trouble.

But the problem was that Boeing didn’t make a full disclosure of the Lockheed papers it possessed, but instead “identified only a few relatively insignificant documents,” McNulty testified.

It wasn’t until two years later that Lockheed, in a civil lawsuit against Boeing, discovered that Boeing possessed more of its documents.

“This discovery prompted Lockheed to refer the matter to the Air Force and the Department of Justice, which triggered an investigation by the Defense Criminal Investigation Service along with the Los Angeles United States Attorney’s office,” McNulty said.

From here, he continued, the EELV investigation expanded into other space-related programs where Boeing competed with Lockheed, “another Air Force procurement for the Exoatmospheric Kill Vehicle.”

The EELV program began in the 1990s as a way to provide standardized interfaces for existing launch systems that was intended to save the government money. The EKV is a component at the tip of the Ground-based Midcourse Defense system, one element of the multi-layered U.S. defense against enemy ballistic missiles. The EKV smashes into an incoming enemy weapon to destroy it.

As the probe continued and expanded, it considered NASA allegations that “involved a billion-dollar task order that was awarded to Boeing” as a sole source deal, McNulty continued.

“The issue there was whether Boeing’s alleged fraud in the EELV competition gave the company an unfair advantage in the NASA procurement, so much so that NASA was persuaded to award the task order to Boeing without giving Lockheed even the opportunity to compete,” McNulty explained.

In 2003, a grand jury indicted Branch and Erskine on charges of conspiring to conceal and possess trade secrets, and their trial is slated to begin late this year.

The DOJ also was confronted with another matter involving Boeing, in which a senior Air Force procurement policymaker, Darleen Druyun, negotiated a job for herself with Boeing at the same time that she negotiated a deal for the Air Force to acquire 100 Boeing KC-767 aerial refueling tanker aircraft for $23.5 billion.

Ultimately, the DOJ had to decide what issues to resolve with criminal prosecutions, and which would be solved with civil remedies, including the largest penalty ever paid by a defense contractor.

On the criminal side, Druyun and the Boeing CFO who hired her, Mike Sears, both wound up serving time in prison. Branch and Erskine as well face criminal charges.

But DOJ decided not to pursue criminal allegations against Boeing itself, because the company had taken many steps to counter its improper conduct, McNulty said.

“These factors include Boeing’s timely and voluntary cooperation in the Druyun matter; its willingness to cooperate in the investigations” of the EELV/EKV and tanker matters, “the company’s policies and procedures in place at the time of the [mis]conduct; the remedial actions taken by Boeing, including efforts to improve and make more effective its corporate compliance program; its termination of the wrongdoers; and the adequacy of other remedies, including civil settlement.”

As well, Boeing “accepted and acknowledged responsibility for the conduct of its employees in the EELV and Druyun matters,” McNulty said.

In other words, Boeing’s actions, including McNerney’s reform efforts and settlement/tax decisions, provide a road map, a how-to of the right steps for any contractor to take if it lands in hot water over ethical lapses.

McNerney provided a clear example of his face-up-to-it, clean-sweep approach at the SASC hearing.

McNerney acknowledged that “Boeing is accountable for what occurred. And we have cooperated with the government throughout this process.”

He quarreled with neither the $615 million settlement nor the loss of $1 billion worth of business that Boeing suffered because of the launch program documents controversy.

“This settlement is tough–but fair,” McNerney testified, noting that it is described as the largest monetary settlement by a defense contractor. He said that it is “a sad ‘distinction’ we must live with and learn from.”

The investigation of Boeing controversies, and the Boeing response in the settlement deal and decision not to seek a tax writeoff, will serve as a wake up call for the entire community of contractors, Warner said. This “will serve as a model for all of America’s” industrial base of contractors, acting to “shore up business ethics and conduct,” he predicted.

Likewise, McCain–a tough senator who helped to bring the Druyun matter to light in the first place–gave Boeing and McNerney a strong endorsement. “We share your view of the integrity of the new Boeing management team,” he said.

Another point that became clear during the hearing is that Boeing has had its share of unfavorable publicity and has risen to the challenge by cleaning house and adopting new ethical programs. But other contractors may be just starting down that rough road.

McNulty told the SASC that Boeing isn’t alone in having ethical problems, and the government is examining the contracting industry.

A procurement fraud task force in the next 60 days will have details worked out of a plan to go after other wayward firms, he said.