FCPA Compliance: Third-Party Due Diligence Minimizing Corruption Risks When Using Foreign Agents, Distributors and Other Intermediaries Today’s faculty features: 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10. WEDNESDAY, AUGUST 6, 2014 Presenting a live 90-minute webinar with interactive Q&A Kathryn Cameron Atkinson, Member, Miller Chevalier, Washington, D.C. James D. Slear, Partner, Thompson Coburn, Washington, D.C.
Transcript
FCPA Compliance: Third-Party Due Diligence Minimizing Corruption Risks When Using Foreign Agents, Distributors and Other Intermediaries
The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
WEDNESDAY, AUGUST 6, 2014
Presenting a live 90-minute webinar with interactive Q&A
Kathryn Cameron Atkinson, Member, Miller Chevalier, Washington, D.C.
James D. Slear, Partner, Thompson Coburn, Washington, D.C.
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M i t i g a t i o n o f C o r r u p t i o n R i s k s
w h e n u s i n g T h i r d P a r t i e s A b r o a d
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FCPA Compliance: Third Party Due Diligence
Recurring Theme: Third Party Liability
“DOJ’s and SEC’s FCPA enforcement actions demonstrate that third parties, including agents, consultants, and distributors, are commonly used to conceal the payment of bribes to foreign officials in international business transactions.”
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Whistle Blower Risks
Dodd-Frank Wall Street Reform and Consumer Protection Act added Section 21F to the Exchange Act providing incentives for whistleblowers Information about violations of securities laws, including FCPA.
Awards range from 10-30%
There were 149 FCPA tips to the SEC in 2013, up from 115 in 2012.
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Antibribery Violation Elements
Offer, payment, promise or authorization
Anything of value
To foreign official (directly or indirectly)
Corrupt intent
“Intent or desire to wrongfully influence the recipient”
To obtain/retain business or direct business to any person
“Business purpose test: any “unfair business advantage” (e.g., avoiding Customs duties, seeking confidential bidding information)
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Anything of Value
Any tangible or intangible benefit Cash, cash equivalents (including to related parties) Travel or entertainment (DOJ example: $10,000 for dinners, drinks, and
entertainment for a government official) Guarantees, discounts, free products or services Offers of employment or other benefits to a family member Charitable contributions (even to a legitimate charity)
“Appropriate” gifts are permissible “Necessarily fact specific” Hallmarks: given openly and transparently, properly recorded, provided only to
reflect esteem or gratitude, and permitted under local law
The larger or more extravagant more likely improper purpose
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Foreign Officials
Any officer or employee of government department, agency or instrumentality or any public international organization (e.g., UN, EC, IMF or International Red Cross)
Any political party or party official, or candidate for political office
Any person acting in the capacity of a foreign official Broadly construed by the DoJ/SEC
Any officer or employee (including low-level employees and officials) of government-owned or government-controlled businesses and enterprises (i.e., government instrumentalities)
Example: Doctors at government-controlled hospitals
Some district courts had developed factors to determine as issue of fact
11th Circuit recently defined “instrumentality” as (1) an entity controlled by the government of a foreign country that (2) performs a function the controlling government treats as its own. United States v. Esquenazi
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Esquenazi Factors
GOVERNMENT CONTROL Government’s formal
designation of entity
Whether Government has majority interest
Government ability to hire and fire entity’s principals
How the entity’s profits and losses are managed
Length of time these factors have existed
GOVERNMENT FUNCTION
Does entity have a monopoly over function
Does Government subsidize costs of services provided
Does entity provide services to the public at large
Public and government perception that entity is performing governmental function
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DOJ/SEC Guideline Factors
Extent of government ownership of the entity Degree of government control over the entity Government’s characterization of the entity and its employees Circumstances surrounding the entity’s creation Purpose of the entity’s activities Obligations and privileges under the foreign state’s law Exclusive/controlling power vested in entity to administer designated
functions Level of government financial support Provision of services to residents Whether governmental end or purpose is expressed in government policies Perception that the entity is performing official or governmental functions
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Payments to Third Parties
FCPA expressly prohibits corrupt payments through third parties Specifically, covers payments to “any person, while knowing
that all or a portion of such money or thing of value will be offered, given, or promised, directly or indirectly, to a foreign official”
DOJ Guidance: “Although [ ] foreign agents may
provide entirely legitimate advice regarding local customs and procedures and may help facilitate business transactions, companies should be aware of the risks involved in engaging third-party agents or intermediaries.” 13
Liability for Third Party Payments
How much knowledge?
“Substantially certain” corrupt payment will be made
Aware of “high probability” corrupt payment will be made
Liable if there is . . . .
“Reckless disregard” “Conscious avoidance”
“Deliberate Ignorance” 14
Head in the Sand: No Protection
Frederic Bourke’s year in jail and $1 million fine Investment in failed plan to privatize petroleum industry in Azerbaijan Invested in entity had reason to know intended to bribe Azerbaijan officials
Aware of pervasive corruption in Azerbaijan Knew reputation of business partner as “Pirate of Prague” known for “shady
dealings” Created the American advisory companies to shield himself and other American
investors from potential liability from payments made in violation of FCPA
“Knowledge may be proven [if] the person suspects the fact, realized its high probability, but refrained from obtaining the final confirmation because he wanted to be able to deny knowledge”
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Third Parties
Local agents/sales representatives Consultants/advisors Subcontractors Subsidiaries JV Partners Distributors Freight forwarders Other intermediaries
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Common Red Flags (DOJ Guidance)
Excessive commissions to third-party agents or consultants Unreasonably large discounts to third-party distributors “Consulting agreements” with vaguely described services Third-party consultant is in a different line of business than that
for which it has been engaged Related to or closely associated with foreign official Third party became part of the transaction at the express request
or insistence of the foreign official Third party is a shell company incorporated in offshore
jurisdiction Requests for payment to offshore bank accounts
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Other Red Flags for Third Parties
• Abnormal use of cash payments • Requests that commission be split or paid to another party • Claims of special relationships with government officials • Personal or professional ties to the government • Employs retired officials from relevant government entity • Employs unnamed consultants or insists on using a particular contractor • Required payment in advance of contract award • Pressure for payments ahead of schedule • Abnormal access to “inside” information • Private meetings with government officials • Lack of relevant expertise expected in business area • Lack of adequate resources to do work • Limited or no work product • Refusal to agree to audit rights • Bad reputation
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Agents
Bridgestone Corporation (2012). When subsidiary secured business for marine hoses in Latin America, it paid the local sales agent a “commission” inflated to allow for payments to employees of the state-owned customer.
UTStarcom, Inc. (2009): U.S. telecom company allegedly paid $1.5m to the company’s agent in Mongolia, claiming that it was for a “license fee.” Fee was only $50k; balance used to make improper payments to a government official
United Industrial Corp. (2009): Payments through a subsidiary to a retired Egyptian Air Force (EAF) general with conscious disregard of the high probability he would pass payments to EAF officials to influence award of a contract for aircraft depot.
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Subsidiaries
DOJ Guidance on parent liability for subsidiary’s conduct under agency principles “evaluate the parent’s control—including the parent’s knowledge and direction of
the subsidiary’s actions, both generally and in the context of the specific transaction”
Schnitzer Steel Ind. Inc. (2006): Alleged bribes by subsidiaries and employees to
obtain business states: “Schnitzer Steel accepts and acknowledges that it is responsible for the acts of . . . its wholly owned subsidiary” See also Ralph Lauren case in which parent appeared to be held strictly liable for bribery by foreign subsidiary.
Oscar Meza (former Director of Asia-Pacific Sales for Faro Technologies, Inc.) (2009): Agreed to country manger request to do business “the Chinese way” authorized subsidiary to pay “referral fees” to employees of Chinese state-owned companies to obtain contracts.
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Freight Forwarders/Logistics Companies
Panalpina World Transport (2010): Swiss company
bribed numerous foreign government officials on behalf of customers to circumvent local customs processes in various countries. PWT, its U.S. subsidiary and a number of its customers were fined.
Ralph Lauren Corporation (2013): Argentine subsidiary
paid bribes and gifts through customs broker to customs officials to assist in improperly importing goods and avoid inspections.
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Consultants
JGC Corp. (Bonny Island cases) (2011). Company’s JV entered into sham consulting or services agreements through which bribes were negotiated and paid to Nigerian officials
Alcatel-Lucent SA (2010): French issuer’s senior executives approved retention and payment of millions of dollars to consultants with no relevant experience or in other cases despite obvious indications that the consultants were performing little or no legitimate work.
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Distributors
Pfizer H.C.P. (2012). Pfizer entered exclusive distribution contract with Kazakh company, believing at least some value from the contract would be given to a Kazakh government official to ensure registration of a Pfizer product in Kazakhstan.
Weatherford Services Limited (2013): Subsidiary provided volume discounts to Iraqi distributor believing those discounts would be used to create slush fund to make bribes to foreign officials of a government-owned national oil company.
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Subcontractor
Data Systems & Solutions LLC (2012). Paid bribes to officials at Ignalina Nuclear Power Plant
through third-party subcontractors in exchange for large contracts
Disguised through fictitious scopes of work to subcontractors and paid at above-market rates
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Joint Venture Partners
Weatherford Services Limited (2013) Employees established JV in Africa with two local entities controlled
by foreign officials.
JVPs did not contribute capital, expertise or labor.
Sole purpose of JVPs was to funnel payments to the foreign officials controlling them.
Foreign officials awarded JV lucrative contracts, gave WSL inside information about pricing, and took contracts away from competitors.
Combined Corporate Enforcement Actions Involving Third Parties* 1992 through 2013
5
* These statistics combine all related resolved enforcement actions involving each company and its subsidiaries and affiliates. **2012-2016 numbers are estimated based of pace of enforcement through December 31, 2013.
Vicarious liability for the acts of third parties: • Agents • Sales representatives • Vendors (e.g., travel agents) • Consultants • Subsidiaries • Professional advisors • Travel agents • Joint venture partners • Relatives of officials • Others
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As Applied: Directly or indirectly
How can you be aware of a high probability? Hiring a 3rd party who was
likely to pay Failing to investigate 3rd
party risks (at any stage) Making 3rd party payments
contrary to company policy 3rd party agrees to demand
for payment
Under the FCPA, a company or individual can be liable for payments made by a third party (like a consultant) if there was awareness of a “high probability” that a payment would be made.
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Third Party Risk: DOJ/SEC Resource Guide
• All types of third parties present risks • Focus on risk-based due diligence, with increasing
scrutiny as red flags are uncovered • An effective compliance program will include
mechanisms to reduce risk at all stages of the third party relationship
• Past enforcement actions and published lists of common red flags are sources of guidance
• Ch. 5 hypotheticals provide additional detailed guidance
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Third Party Risk: Joint Ventures
• Level of investment and control important • Due diligence can be difficult depending on bargaining
power • Due diligence essential to facilitate proper agreement
safeguards upon entry into the JV • RAE Systems shows need to conduct due diligence
prior to formation, as well as need to implement safeguards in response to the due diligence findings
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Third Party Risk: Professional Advisors
• Professional consultants and advisors create can create FCPA risks
• Baker Hughes involved bribes paid by the local Indonesian affiliate of KPMG to tax officials to reduce the Company’s tax bill, disguised in an inflated KPMG invoice
• TSKJ Bonny Island scheme involving Halliburton/KBR and others funneled bribes to Nigerian officials in part through Jeffrey Tesler, a U.K. lawyer
34
State-Owned Enterprises as Third Parties: Design Institutes
In some countries, your third party may be a state-owned enterprise, raising additional compliance risks and due diligence challenges Rockwell Automation highlights compliance challenges of working with Design Institutes: • Employees of wholly-owned subsidiary, RAPS-China, made payments to employees of Design Institutes through third-party intermediaries • The Design Institutes provided some bona fide services to RAPS-China • The Design Institutes also offered recommendations to RAPS-China’s anticipated ultimate customers, i.e., Chinese government-owned mining companies • RAPS-China's Marketing and Sales Director intended the payments to influence the award of sales contracts
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State-Owned Enterprises as Third Parties: Design Institutes
In some countries, your third party may be a state-owned enterprise, raising additional compliance risks and due diligence challenges Rockwell Automation highlights compliance challenges of working with Design Institutes: • Employees of wholly-owned subsidiary, RAPS-China, made payments to employees of Design Institutes through third-party intermediaries • The Design Institutes provided some bona fide services to RAPS-China • The Design Institutes also offered recommendations to RAPS-China’s anticipated ultimate customers, i.e., Chinese government-owned mining companies • RAPS-China's Marketing and Sales Director intended the payments to influence the award of sales contracts
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Third Parties Everywhere: Diageo 2011
Diageo’s 2011 settlement revealed its use of various third party structures to make improper payments: • In India, Diageo’s subsidiary used distributors and other third parties to make improper
payments to officials to increase sales of liquor to government-run stores • Payments were funded through inflated commission payments to distributors, who
passed on the money to officials. • In Thailand, Diageo’s joint venture made payments to an official’s consulting firm
(including reimbursement for entertainment expenses) for the official’s lobbying services to resolving tax disputes (the accounting records concealed his direct involvement).
• In South Korea, Diageo’s subsidiary provided cash, travel and entertainment to customs officials to obtain a favorable tax rate, including kickbacks paid through their customs broker. Travel for these officials included a purely recreational side trip to Budapest and Prague.
• The Korean subsidiary also made hundreds of small “rice cake” payments (in cash or gift certificates) and “relationship” payments to South Korean military officials involved in liquor procurement.
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What is the Goal?
Mitigate FCPA risk presented by third parties who will stand between you and foreign officials, recognizing that third parties: -- may not share your commitment fully; and/or -- may not appreciate the vigilance and adherence to process required to protect against violations; and -- are not fully within your control
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What Are Key Characteristics?
• Design a process that: Covers the appropriate universe of third parties Is tailored to risk Is tailored to resources (cost and time efficient) Can be implemented consistently across the
organization Generates an adequate written record Provides for centralized knowledge at some level Provides for periodic updates Effectively protects the organization against risk
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What are the Questions to be Answered?
• Why do we need a third party? • Why do we need/want this third party? • What is the value of this third party’s services? How do we
know? • What are the reasonable ways to pay for that value? • How do we ensure that the third party provides the value for
which we are paying? • Will this third party conduct business consistent with our
ethical and legal obligations, and our expectations? • How have we protected ourselves against the risk that we
are making the wrong judgment?
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Addressing Third Party Risks: Due Diligence Policies/Procedures
• Pre-engagement due diligence Internal proposal Internal reference check Questionnaires and verification Interview(s) External reference checks Public data searches (incl. local press and “blacklist”) Local law check Identification/investigation of specific “red flags”
• Notification of company gatekeepers
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Addressing Third Party Risks: Due Diligence Policies/Procedures
• Benchmarking/justifying proposed compensation • Interviews • Written contract requirements • Incorporation of safeguards to address red flags • Measures consistent with level of control for JVs • Address process for monitoring, audits, certifications,
and updates at formation • Multiple company approvals/sign-offs • Awareness training (for third parties and “minders”)
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Addressing Third Party Risks: DOJ/SEC Guide Consultant Hypothetical
Company seeking to expand into high-risk Country X learns of $50m Ministry of Immigation contract tender SVP of International Sales suggests local
businessman as 3rd party 3rd party claims strong ties to government and political
leaders, can help win the contract Company enters contract: Best efforts to win the contract Retainer plus success fee of 3% of contract value
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Addressing Third Party Risks: DOJ/SEC Guide Consultant Hypothetical Red flags: High Risk Country Size and significance of deal to the Company First-time use of this 3rd party Claimed strong ties to officials Success fee structure Vaguely-defined services
Due Diligence Response: Background and reference checks Detailed description of services in contract (including status reports) Anti-corruption training for 3rd party Anti-corruption compliance language in contract Obtain and exercise audit rights Ensure proper documentation for payments
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Addressing Third Party Risks: DOJ/SEC Guide Distributor/Partner Hypothetical
Distributor learns of opportunity, proposes to expand services to market Company to Ministry Distributor requests increased discount/rebate or lump sum/success fee given
anticipated after-sales services Distributor reports Ministry prefers local company work as subcontractor (on
work Company or Distributor would normally perform) Subcontractor has solid relationship with Ministry, so will do most work on-site One of Subcontractor principals (Principal 1) is an official in another Ministry
Due Diligence Response: What is economic justification for compensation proposed? Disconnect
between justification offered and presence of subcontractor? Extra scrutiny of relationship among Distributor, Ministry, and Contractor Additional safeguards (certification, recusals, notice) re: Principal 1’s role
45
Addressing Third Party Risks: DOJ/SEC Guide Distributor/Partner Hypothetical
Retention requires Finance and Compliance approval Finance questions deep discounts, and overlap in services, requests meeting with
Distributor and Principal 1 to discuss Meeting shows Principal 1 has no substantive qualifications, and Distributor cannot
support discount with any analysis Distributor complains to SVP that Finance doesn’t get “how business is done” SVP dismisses Finance concerns and reminds Finance deal is important to Company
Compliance conducts due diligence on Distributor, Local Partners Distributor reputable, qualified, and financially stable Local Partner founded 2 years ago, financially stable, no expertise in industry Both 3rd parties have opened new offshore accounts/shell entity for this transaction Principal 1 was college roommate of Minister SVP dismisses Compliance concerns, defends all as legitimate business structures
and argues questionnaire and contractual safeguards are sufficient to protect the Company
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Addressing Third Party Risks: DOJ/SEC Guide Distributor/Partner Hypothetical
Compliance and Finance sign off, even though concerns not addressed Distributor and Local Partner pass compensation through to Minister and others
to secure the contract SVP also receives money from 3rd parties in his own offshore account
DOJ/SEC Enforcement Analysis: SVP not a rogue Due diligence was incomplete Reliance on questionnaires and contract safeguards not enough given red flags SVP appears to have actual knowledge of payments, or at least willfully blind and
discouraged others from following their instincts = personal liability under antibribery and accounting controls provisions
Company may also be liable; significance and number of red flags left unaddressed rise to “high probability”
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Accounting Provisions: Internal Controls
• Payments contrary to company policies (Chiquita) • Payments without prior due diligence (InVision) • Failure to document payments (Titan) • Failure to provide FCPA training to consultant (Oil States
International) • Failure to implement adequate internal controls at JVs and
subsidiaries post-acquisition (RAE, Diageo) • Misrepresenting payments to third parties in books and
records (e.g., recording bribes paid through distributor as “commissions”) (Diageo)
Two: Determine value sought from third party Why do we need a third party? Why was this third party selected? What value is the third party providing?
Three: Assess competence of third party Qualifications (expertise, resources) to provide desired services
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Ten Steps for Due Diligence
Four: Determine integrity of third party Open source research and restricted party lists (U.S. and others) References, interviews, discreet inquiries Third party audits Cooperation (e.g., audit rights)
Five: Identify relationships with government officials Interview or Questionnaire Identify directors / officers / key employees Require information about past/present relationships with
government List of anticipate non-employee resources
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Ten Steps for Due Diligence
Six: Determine reasonableness of compensation Is pay commensurate with the effort expected? Special payment terms (advances, split payment, off shore
accounts)
Seven: Verify due diligence responses Verify information received from consultant with interviews of
business references and background search or third party diligence
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Ten Steps for Due Diligence
Eight: Integrate FCPA safeguards into the contract Certifications Audit rights
Nine: Provide for continuing oversight of the activities of third party Develop compliance plan Assign responsible employee
Ten: Ensure accurate books and records Periodic review Training 53
Final Thoughts
No one-size fits all solution
Recognize and mitigate risk
Adequate due diligence may be costly (e.g., Burma)
Training is an essential complement to due diligence
