Maybellene and the 2014 Anti-Bribery and Corruption Benchmarking Report

Today, we celebrate an event, which is not ‘the day the music died’ but one that might properly be called one of the seminal moments in the creation of Rock N’ Roll. On this date in 1955, Chuck Berry recorded his first song, Maybellene. John Lennon once said of Chuck Berry “if you tried to give rock and roll another name, you might call it ‘Chuck Berry.'” Chuck Berry created the do-it-yourself template that most rock-and-rollers still seek to follow. If there can be said to be a single day on which his profound influence on the sound and style of rock and roll began, it was this day in 1955, when the unknown Chuck Berry paid his first visit to a recording studio and cut the record that would make him famous.

I am attending Compliance Week 2014 for the 5^th consecutive year. Once again Matt Kelly and his team have put together one of the top compliance events of the year. The sessions have been first rate, the conversations highly informative and the sponsors are talking about their compliance solutions in an exciting and engaging manner. If you did not make Compliance Week 2014, I hope that you will make it next year for Compliance Week 2015.

One of the sessions I attended was a presentation of the joint Kroll/Compliance Week 2014 Anti-Bribery and Corruption Benchmarking Report. Compliance Week Editor, Matt Kelly, moderated the panel with Kroll Inc., representatives Alan Brill, Senior Managing Director, and Lonnie Keene, Managing Director, which discussed some of the reports key findings, the highlights of which are as follows.

Risks

For the second year in a row, large US Corporations were much more likely to say they expect bribery and corruption risks to increase than smaller or overseas

Corporations do. Some 51 percent of respondents said they expect more such risks in the next two to three years – as did 57 percent of US companies, and 57 percent of large companies, which was defined as having $5 billion or more in annual revenue. However, only 37 percent of overseas businesses, and 46 percent of smaller companies expect their corruption risks to keep rising. A question that Chief Compliance Officers (CCOs) may ask, then, is whether their assessment of bribery risks is accurate? The “risk perception gap” between large and small, or US and overseas, does exist, and an erroneous understanding of one’s risk profile can have dire consequences.

Third Part

The conundrum of third party risks continues to be a major weakness for anti-corruption programs and the problem may well be getting worse. The respondents this year reported an average of 3,868 third parties, yet 58 percent say they never train third parties on anti-corruption efforts. That number is higher than last year, when 47 percent said they do not educate third parties on anti-corruption policies. Significantly, the number of companies that conduct due diligence on third parties has increased, from 87 percent in 2013 to 97 percent this year – which suggests that companies do now grasp the importance of performing due diligence and have the processes in place to do so. That next step of training third parties (which can indeed be expensive) is where compliance programs start to falter.

Third party risks do hinge on several factors, such as the number of third parties one has or the corruption environments where they are. Another question that CCOs can ask themselves, then, is how the need for the services provided by their third parties matches up with the risk they pose to their companies.

Due Diligence

This was an area noted to be “a bright spot in the 2014 ABC Report.” In addition to the 97 percent of respondents who perform due diligence on third parties, 92 percent say they perform at least some due diligence on merger and acquisition (M&A) targets to identify possible corruption risks before a deal is done. What’s more, 74 percent say they start by investigating the target company’s management team – which is where the most serious corruption risks typically hide. Due diligence on a target company’s third parties fell off sharply: only 54 percent also performed due diligence on a target’s agents, 52 percent on its distributors, 50 percent on its consultants, and 46 percent on its suppliers. The report indicates that larger companies were much more likely than smaller ones to perform due diligence on a target’s third parties.

 

Overall Compliance Program Effectiveness

 

The Report revealed that seventy percent of respondents rated their policies for domestic employees as effective or very effective – and larger companies were more bullish about their domestic employees than smaller ones (77 percent to 61 percent, respectively). That statistic edged downward for confidence in training overseas employees, to 66 percent, driven by considerably fewer companies saying they were very confident in their training of overseas workers.

However, compliance practitioners were more confident in their ability to vet third parties at the start of a relationship, but less confident in monitoring third parties once that onboarding examination had passed. Fifty-seven percent of respondents rated their vetting procedures as effective or very effective. Then the numbers marched downward for monitoring compliance after a relationship starts, auditing compliance of third parties, and training third parties on anti-bribery and corruption procedures.

This led to the conclusion that effective compliance programs can help a company identify corruption risks when the CCO is not specifically hunting for them. That may come from strong training in a speak-up culture, or strong audits of third parties, or any number of other techniques. The key question here is to ask what metrics and corruption risk indicators match the risks you believe you have, and how your compliance can implement those solutions.

These trends stand against a background where large US Corporations report that they expect bribery and corruption risks to increase considerably more than smaller or overseas corporations do. Given the globalized nature of modern business, with more regulatory scrutiny from more regulators, and the “extended enterprise” extending to include even more third parties, the Report then asks “Do smaller or non-U.S. businesses truly have fewer corruption risks, or do they misunderstand the risk profile they have?”

While perhaps not as groundbreaking as Chuck Berry’s achievement in 1955, this 2014 Anti-Bribery and Corruption Benchmarking Report, captures important information about the current state of compliance and, more importantly, where it may need to go.

For a YouTube clip of Chuck Berry belting out Maybellene, click here.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2014

Esquenazi Part II – the Test for Determining an Instrumentality under the FCPA

In Part I of my review of the 11^th Circuit Court of Appeals decision in the Esquenazi case, I reviewed the Court of Appeals opinion. Today, in Part II, I want to drill down further and examine the test developed by the Court of Appeals to use in determining whether an entity is an instrumentality under the Foreign Corrupt Practices Act (FCPA) and compare it with the two prior formulations developed by District Courts in the Carson and Lindsey cases. The chart below consolidates the factors raised by the courts.

Key Inquiry	Lindsey	Carson	Esquenazi
Characterization of Services	Entity provides services to citizens, in many cases all in country	Foreign states characterization of the entity and its employees	Function Test – Does the entity provide services to the public at large in the foreign Country?Control Test – the foreign government’s formal designation of the entity.
Hiring and Firing	Are key officers/ directors government employees or appointed by government employees	Foreign State’s control over the entity	Control Test – the government’s ability to hire and fire the entity’s principals.
Financial Control/ Funding	Is entity financed, or in large measure, by government appropriations or through government mandates?	The foreign state’s extent of ownership of the entity, including the level of financial support by the state	Function Test – Does the foreign government subsidize the costs associated with the entity providing the services?Control Test – the extent to which the government funds the entity if it fails to break even.
Foreign Government Control of Administrative Functions	Is entity vested with or does it exercise exclusive/controlling power to administer its designated functions?	The Entity’s obligations and privileges under country’s laws, including whether it exercises exclusive/ controlling power to administer its designated functions
Perception as Governmental Entity	Is entity widely perceived and understood to be providing official functions?	Purpose of the entity’s activities	Function Test – Does the foreign government generally perceive the entity to be performing a governmental function?Control Test – Whether the foreign government has an interest in the entity
Creation		Circumstances around the entities creation
Length of Time			Control Test – the length of time the indicia have existed.
Monopoly over Market			Function Test – Does the entity have a monopoly over the function it exists to carry out?

 

The Esquenazi decision separates the analysis into two basic questions (a) does a foreign government control an entity and (b) does the entity perform a function the foreign government treats as its own? The Court of Appeals then breaks the analysis of these two questions into a series of inquiries. The prior District Court opinions in Lindsey and Carson did not have such an initial dichotomy; nevertheless the 11^th Circuit’s analysis has clear overlap with the prior District Court formulations. (Please note that I have not discussed the district court formulation at the Esquenazi trial level as that analysis has been superseded by the Court of Appeals decision.) Between the Lindsey, Carson and Esquenazi factors, we see the following:

Identical – does the government appoint the officers/directors and is the entity understood to be owned by or an agency of the government in the home country? In Lindsey and Esquenazi (Control Prong), the courts agree on Inquiry 2 above, the ‘Hiring and Firing’ inquiry, while Carson says the inquiry is simply over foreign government control of the entity. Inquiry 5 in both Lindsey and Esquenazi (Control and Function Prongs) is the ‘Perception’ inquiry, while the Carson court denominates this inquiry as the ‘Purpose’ inquiry. Finally, in Inquiry 3 all Courts consider the financial support provided to the entity by the foreign government, with the Esquenazi Court (Control and Function Prongs) adding the analysis around the “Extent of obligations and privileges under its country’s laws”.

Similar – Inquiry 1 – Are the services provided by the entity available to all citizens of the home country?; and Inquiry 4 – Does it exercise exclusive/controlling power to administer its designated functions and the extent of obligations and privileges under its country’s laws? In Lindsey and Carson, the similar factors are in Inquiry 1, the Characterization of the services provided. The Esquenazi opinion has this Inquiry 1 in both the Function and Control Prong analysis. Under the Function Prong analysis it asks “Does the entity provide services to the public at large in the foreign Country?” and under the Control Test it inquires into what is the foreign government’s formal designation of the entity. In Inquiry 4, both the Lindsey and Carson court said that a foreign government’s control over the administrative functions of the entity was a key inquiry but interestingly, this factor was not present in the Esquenazi analysis, under the analysis of either the Control or Function Prong. In Inquiry 6, the Carson Court looked into the creation of the entity and the Esquenazi opinion (Control Prong) inquired into the foreign government’s designation of the entity

Stand-alones – Interestingly, Esquenazi has two factors for analysis not found in either of the district court opinions. The first, Inquiry 7, is from the Control Prong and asks the question of the length of time the various factors listed have existed. The second, Inquiry 8, is from the Function Prong and is whether the entity has a monopoly in the foreign country. Carson also has a stand-alone inquiry, which is found at Inquiry 6 and inquires into the facts and circumstances surrounding the creation of the entity. While I believe this could well be the last factor in your analysis, it can be one, which most easily is ascertained. Most government entities will disclose how they were formed; this information can be found on their website or within their company history. If you cannot determine how a business was formed perhaps you need to think hard about doing business with them.

Comparison of Approaches

At first blush it may appear that the Esquenazi court took a slightly different approach by dividing the two initial prongs of inquiry into ‘Control’ and ‘Function’. If one examines the individual Esquenazi factors in detail they are not significantly different from Lindsey and Carson, with the exception noted above of the two stand-alone inquiries. One clear factor that Esquenazi has in common with Lindsey and Carson is the factor of the entity’s obligations and privileges under its country’s laws, including whether it exercises exclusive/controlling power to administer its designated functions. Carson combines two of the Esquenazi factor of the extent of government ownership and financial support by the foreign government. While Carson does not speak to financial ownership it does have the factor of government financing and government appointment of officers and directors. Carson speaks to the entity’s purpose while Lindsey and Esquenazi list the factor of providing services to the country’s citizens. Indeed the only factor included in Carson and not found in Lindsey and Esquenazi is the following: the circumstances around the entity’s creation. It is incumbent to note that both the Lindsey and Carson court opinions and the Esquenazi 11^th Circuit opinion all have language that indicates these factors are not exclusive, and no single factor will determine whether an entity is an instrumentality of a foreign government.

What to make of the two stand-alones found in Esquenazi; those being lengthy of time the entity has existed (Function Prong) and does it have monopoly power (Control Prong)? I would have to opine that these are the two least important factors listed. I say this because if there is clear indicia that an entity is controlled by, financed in whole or in part by a foreign government, perceived to be run by a foreign government and the entity provides services to the citizens of the foreign country; it really does not matter when it was created, i.e. yesterday or 50 years ago. It will be considered as an instrumentality under the FCPA. Similarly, even if there is no monopoly present, if these other factors are present, it will still be considered an instrumentality under the FCPA.

Lessons Learned

With all this information in mind what inferences can a compliance practitioner for guidance draw on whether a business is an instrumentality under the FCPA? Reviewing the foregoing, the factors can be distilled down to a manageable list, which I believe is as follows:

1. Ownership/Financial Control – There is no percentage amount listed but the inclusion of financial control would clearly indicate that anything over 50% would be a significant factor.
2. Actual control is key in all three court decisions. In Lindsey and Esquenazi, it is characterized as the government’s right to appoint key officers and directors. In Carson, it is called government control. But this means that if actual control is exercised by the government in question, it may trump the 50% guidance stated above.
3. Privileges and Obligations are also mentioned in all three. Does the entity have the right to control its own functions?
4. Financing – Is the entity a for-profit entity, financed through its own revenues or does it depend on financing by its government?
5. Perception is Reality – André Agassi’s immortal words appear again. If it is widely perceived to be providing an official function, then it is an instrumentality under the FCPA.

The Esquenazi Court of Appeals decision is a very welcome addition to the dearth of case law interpretation of the FCPA. The 11^th Circuit has seemingly put to rest the question of whether an instrumentality means only a government agency or something else. Clearly it means something else. The Esquenazi decision also provides significant guidance on what type of inquiry a company should use to determine if an entity is a part of a foreign government and, therefore, subject to FCPA scrutiny. Whatever specific facts or indicia that you are looking at, it now boils down to (1) does a foreign government control the entity?; and (2) does the entity function as part of the part of the foreign government?

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2014