FCPA Compliance and Ethics Blog

June 14, 2012

MLB Standings, the Luxury Tax and FCPA Investigation Costs

The baseball season is nearly 40% complete and there are already several surprises. At least in the National League (NL) two of the biggest surprises are that the Washington Nationals are leading the NL East while the five time division champions Philadelphia Phillies are trailing the field in last place. Last week I was lucky enough to attend games at both teams’ home parks. The Nationals fans were fired up throughout and the Phillies had a matinee performance sell-out. Jim Crane, are you listening? Nothing puts fans in the seats like a winning team.

I thought about the collation between the amount of money spent on each team and their respective standings. Interestingly, I found that the Phillies have the second highest payroll in Major League Baseball (MLB) at just over $174MM, while the Nationals have the 20th highest at just over $81MM. The sad sack Houston Astros come in at 28 out of 30 with a total payroll spend of $60MM. Additionally, they are also the 28th worst team in MLB. Coincidence? Jim Crane, are you listening? To win you have to spend money, not just buy the team and then immediately cave in to MLB by agreeing to go to the American League (AL) West.

I thought about these overall team costs whilst reading a recent article by Jaclyn Jaeger in the Compliance Week Magazine, entitled “High Cost of Conducting Full FCPA Investigations”. In her article, Jaeger reported the costs of some very large and ongoing Foreign Corrupt Practices Act (FCPA) investigations, which are reflected in the FCPA Investigation Cost Box Score below, remember at this point we do not know what the Wal-Mart investigative costs are to-date.

Company Length of Investigation Reported Costs
Weatherford 2009 to date $123MM
News Corp July 2011 to date $191MM
Avon 2008 to date $247MM

While noting that not all FCPA investigations have such exorbitant investigative costs, Jaeger quoted “the costliest FCPA investigations are the ones that grab the headlines.” One way to hold down such costs is defining the scope. Attorney Claudius Sokenu was quoted as stating “The important question at the outset of the investigation is scope, because that drives the costs.” However, even if you can define the scope, one of the main reasons for these high investigative costs in a FCPA investigation is the dreaded question “where else?” If your company has had a complete failure of internal controls to allow a FCPA violation in one geographic region, the Department of Justice (DOJ) may want to inquire if it is a systemic problem worldwide. In other words, not mission creep but mission explosion. In addition to a systemic failure of internal controls, it may be that an employee caught paying bribes in one country, who previously worked in another country, may have engaged in similar conduct in his prior postings, meaning you will need to investigate those countries as well. Another red flag that could indicate the “where else” question is if an employee alleged to have engaged in bribery manages a regional office which overseas operations in several countries. This could require an investigation into countries other than the one which may have been the subject of the original investigation.

To understand how this question of “where else” can play out one need only look at the current Wal-Mart internal investigation. In an article in the Wednesday, June 13 Wall Street Journal (WSJ), entitled “Wal-Mart Review Includes India, South Africa”, reporter Shelly Banjo wrote about the expanding Wal-Mart internal FCPA investigation. The allegations originally arose from the company’s operations in Mexico. After the New York Times (NYT) broke the story, Wal-Mart instituted an internal investigation of its Mexico subsidiary and the investigation quickly spread to Wal-Mart’s operations in Brazil and China. This expansion increased again with Banjo’s report that Wal-Mart’s counsel has recommended the internal investigation further expand to include Wal-Mart’s operations in South Africa and India. Soon there may not be much of the globe where Wal-Mart operates which is not under investigation.

So what are some of the ways to hold down investigative costs? One sure way is to not self-disclose and face the “where else” question. Jaeger noted that “sometimes it could be just a matter of promptly implementing remedial measures and revising and enhancing compliance policies and procedures.” Jaeger quoted Sokenu who stated “Only in rare circumstances would I recommend to a client that self-disclosure is the way to go, because no good deed goes unpunished.” Sokenu went on to list some of the factors which he would consider when recommending self-disclosure to the DOJ and Securities and Exchange Commission (SEC).

  • Awareness of a potential whistleblower reporting an incident to the government because “You want to go to government before that whistleblower does.”
  • The conduct in question is “systemic and involves senior management-such as the chief executive, chief financial officer, general counsel or heads of business units.”
  • The incident requires a disclosure which is “required under securities laws anyway.”
  • That the company’s auditors “will not sign off on filings with the Securities and Exchange Commission.”

I have heard Mike Volkov provide a similar list of issues when he discusses the factors you should consider when making a decision to self-disclose. It is certainly not one to be taken lightly. However, Jaeger’s article provides some key elements to consider when evaluating whether to self-disclose a potential FCPA investigation.

Of the costs reported so far only Avon is north of the New York Yankees annual payroll of $197MM but News Corp is closing in quickly. Wal-Mart has not released its costs for its investigation, as yet, but it may well exceed both Avon and News Corp. In MLB, there is luxury tax put on the aggregate payroll of a team to the extent that it exceeds a predetermined guideline level set by the league. For 2011 the MLB cap is $178MM so only one team currently pays this luxury tax (the Yankees with a payroll of $197MM). Now how about the investigative fees paid by companies for failing to have an effective FCPA compliance program?

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, 2012

April 6, 2012

Opening Day is Here – Hope and Melancholy for the Astros and Avon

It is finally here, Opening Day for the Houston Astros. Although Major League Baseball (MLB) opened its 2012 season last week in Japan, I will have to go with my hometown team’s home opener as my official day for the new season. So will the Astros improve on their 106-loss season from 2011? We can certainly hope so. On a somewhat melancholy note, it is the Astros final season in the National League (NL) as new owner Jim Crane threw away our 50 year tradition by agreeing to move the Astros to the American League (AL) West next year. Thanks Jim. But hey, we can still lose games to Albert Pujols, when we are up in the 9th by two runs as he left the St. Louis Cardinals for the mega-zillions of Anaheim’s Angels, when he hits yet another 3 run homer with a 0-2 count.

This week in the compliance world we saw a different type of opening or perhaps the beginning of the end, depending on your perspective, involving Avon. The news this week was not specifically focused on its ongoing Foreign Corrupt Practices Act (FCPA) travails but the takeover bid by a much smaller rival, Coty, Inc. As reported in the April 3, edition of both the Wall Street Journal (WSJ), “Scarred Avon is Takeover Target”, and the New York Times (NYT), “Avon Rebuffs Coty, but Its Weakness Shows”, the German-based cosmetics concern, which is “less than half Avon’s size”, publicly announced a $10 billion takeover bid for Avon.

FCPA Costs for Avon

The FCPA travails of Avon have been well reported. In October 2008, Avon publicly announced it was conducting an investigation for possible FCPA violations related to its China operations. This investigation expanded into a world-wide internal investigation, which at this time is still ongoing with no indication of when an enforcement action, if any, will be concluded. Recently the FCPA Professor, in a post entitled “Business Effects”, reported that the “professional fees and expenses incurred by Avon in connection with its internal FCPA review have approached $250 million – and there hasn’t even yet been an enforcement action.  Over the past three years and doing the math, Avon has spent approximately $225,000 per day on its FCPA inquiry.” As reported by the FCPA Blog, in a post entitled “Suit Alleges Avon Execs Knew About China Bribes”, a recent article by Chris Matthews of the WSJ “reported yesterday that an amended shareholder lawsuit accuses Avon Products of paying a big severance to a former head of internal audit in 2006 to buy his silence about bribes in China.”

In addition to this civil shareholder lawsuit, the FCPA Blog noted that “Joe Palazzolo and Emily Glazer at the Wall Street Journal said in February that the DOJ [Department of Justice] had gone to a grand jury with evidence of FCPA violations against U.S. executives at Avon Products. The WSJ story, based on at least three unnamed sources, said the focus of the grand jury was a 2005 internal audit report by the company that concluded Avon employees in China may have been bribing officials.”

In addition to its FCPA issues, Avon has suffered financial setbacks as well since the original FCPA disclosure. The NYT reported that Avon’s “net income has declined every year since 2008.” It has lost significant stock value during this FCPA investigation and has had its credit downgraded. The WSJ article reported that “Prior to Coty’s offer, Avon’s stock had lost about 30% of its value over the past year, and Standard & Poor’s Corp. cut its credit rating on Avon last month to triple-B, two steps above junk, warning it could fall further as the search for a CEO keeps longer-term planning on hold.” This final reference is to Avon’s move to replace it chief executive Andrea Jung, as reported in the NYT article, “has been criticized by analysts recently.”

Successor Liability Issues under the FCPA

As noted by reporter Sam Rubenfeld, in a WSJ article entitled “Buying Avon Could Bring Coty A Hefty Bribery Risk”, the purchasing entity Coty “could be buying a massive foreign bribery liability if a deal to purchase Avon Products Inc. were to close, experts said.” He wrote that “Successor liability in the FCPA context, known by the shorthand of “buying an FCPA violation,” was the subject of six enforcement actions in 2011.” He went on to quote Rita Glavin, a partner at Seward & Kissel LLP who formerly served as head of the Justice Department’s Criminal Division, who said “You buy a company, you buy their problems.”

So what is Coty up to here? I think that they may have come upon an interesting new wrinkle for companies in a FCPA investigation. Not only do companies face what Avon has gone through in terms of the business effects of a huge cost for an internal investigation, drop in stock value and drop in credit rating but now such an all-encompassing investigation could put a company in play for a takeover – hostile or friendly. While the doctrine of successor liability is alive and well, there are potential protections for any purchaser. First and foremost is the fact that it is Avon which has borne these tremendous costs for the investigation. I have no doubt that as a part of the investigation Avon has identified compliance policies and procedures which should be (ahem) enhanced to prevent any violations of the FCPA going forward. Once again it is Avon which is doing this work and not any acquiring company. In addition to these costs which the acquiring company does not have to incur, the value of Avon is well down, although just how much due to the FCPA investigation may not be quantified at this point, it does not change the fact that its value is significantly lower. Hence any purchase price will be at a reduced amount perhaps even a greatly reduced amount.

Coty Options on Successor Liability Issue

As to the issue of successor liability, I think that Coty can look to different DOJ pronouncements for some comfort. The first is Opinion Release 08-02 (the “Halliburton Opinion Release”) in which the DOJ blessed a go-forward plan proposed by Halliburton, to accomplish due diligence in a post-acquisition mode. The second is found in the Johnson and Johnson (J&J) Deferred Prosecution Agreement (DPA), in Attachment D, “Enhanced Compliance Obligations.” With regard to the acquisition context, it agreed to:

7. J&J will ensure that new business entities are only acquired after thorough FCPA and anticorruption due diligence by legal, accounting, and compliance personnel. Where such anticorruption due diligence is not practicable prior to acquisition of a new business for reasons beyond J&J’s control, or due to any applicable law, rule, or regulation, J&J will conduct FCPA and anticorruption due diligence subsequent to the acquisition and report to the Department any corrupt payments, falsified books and records, or inadequate internal controls as required by … the Deferred Prosecution Agreement.

8. J&J will ensure that J&J’s policies and procedures regarding the anticorruption laws and regulations apply as quickly as is practicable, but in any event no less than one year post-closing, to newly-acquired businesses, and will promptly: For those operating companies that are determined not to pose corruption risk, J&J will conduct periodic FCPA Audits, or will incorporate FCPA components into financial audits.

a. Train directors, officers, employees, agents, consultants, representatives, distributors, joint venture partners, and relevant employees thereof, who present corruption risk to J&J, on the anticorruption laws and regulations and J&J’s related policies and procedures; and

b. Conduct an FCPA-specific audit of all newly-acquired businesses within 18 months of acquisition.

Mike Volkov, writing in his blog, Corruption, Crime and Compliance, in a post entitled “Buying an FCPA Violation: Successor Liability is Alive and Well”, provided the following advice for companies to steer clear of successor liability under the FCPA in an acquisition context:

1.  A pre-closing risk assessment needs to be updated for post-closing risks.

2.  Compliance triage teams need to be assembled and tasks prioritized.  If more resources are needed, this needs to be arranged at or near the time of closing.  Compliance triage teams must have authority and resources to bring an acquired company into the fold.

3.  Compliance triage teams need to work post-acquisition to ensure proper controls and compliance programs are adequately implemented in those high-risk areas and businesses.

4.  Compliance training of new employees and agents has to be a high priority.  It is surprising how many companies fail to even conduct basic training, updating of codes of conduct and basic steps to integrate new employees and agents.

From Opinion Release 08-02, the J&J DPA and Mike Volkov’s thoughts, I believe that Coty could well put together a plan to deal with Avon’s FCPA issues and the DOJ based upon precedent, a strong commitment towards compliance going forward and Coty’s extraordinary cooperation with the DOJ to make all of this work. Although the NYT and WSJ both reported that Avon’s management rejected the Coty offer, if Coty can convince enough Avon shareholders to accept the offer the Avon shareholders might be inclined to consider such an offer at this point.

But it’s Opening Day and my bride and I are off to Minute Maid Park to watch the hometown heroes play the Colorado Rockies tonight. Is the start of this 2012 a harbinger of good things to come for the Astros? Only time will tell. As for Avon, its FCPA travails may have helped to put it in play and Coty may have figured out how to use one company’s FCPA issues as a springboard to a major acquisition. Maybe the new normal for companies in large FCPA investigations/enforcement actions is that they find themselves as take-over candidates. Only time will tell.

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, 2012

December 28, 2010

Top FCPA Investigations of 2010, Part I

Last week, we reviewed our Top 10 Enforcement actions of 2010. In the next two posts we will review our Top 10 investigations of 2010. While enforcement actions can provide the some of the DOJ/SEC most current thinking on FCPA compliance best practices the public information made available during investigations can provide to the FCPA, Bribery Act or other compliance professional many opportunities for teaching points and lessons learned by others. So with the opportunity for many educational occasions in mind we present our favorite investigations of 2010, Part I. 

1. Avon-What is the cost of non-compliance?

As noted by the FCPA Professor, one of the significant pieces of information to come out of the Avon matter is the reported costs as reported in the 2009 Annual Report the following costs have been incurred and are anticipated to be incurred in 2010: 

Investigate Cost, Revenue or Earnings Loss
Investigative Cost (2009) $35 Million
Investigative Cost (anticipated-2010) $95 Million
Drop in Q1 Earnings $74.8 Million
Loss in Revenue from China Operations $10 Million
Total $214.8 Million

 2. Gun Sting Case-Organized Crime Fighting Techniques Come to FCPA Enforcement 

On January 18, 2010, on the floor of the largest annual national gun industry trade show in Las Vegas, 21 people from military and law-enforcement supply companies were arrested, with an additional defendant being later arrested in Miami. The breadth and scope was unprecedented. Assistant Attorney General for the Criminal Division of the US Department of Justice (DOJ), Lanny Breuer, who led the arrest team, described the undercover operation as a “two-and-a-half-year operation”. The arrests represented the largest single investigation and prosecution against individuals in the history of the DOJ’s enforcement of the FCPA. 

As explained in the indictments, one FBI special agent posed “as a representative of the Minister of Defense of a country in Africa (Country A), [later identified as Gabon] and another FBI special agent posed “as a procurement officer for Country A’s Ministry of Defense who purportedly reported directly to the Minister of Defense”. Undercover criminal enforcement techniques such as wire taps, video tapes of the defendants and a cooperating defendant were all used in the lengthy enforcement action. In a later indictment, and seemingly unrelated to the “Africa” part of this undercover sting operation, allegations were included that corrupt payments were made to the Republic of Georgia to induce its government to purchase arms. 

3. HP-Questions, Questions and More Questions 

How does one begin to discuss HP’s compliance year? From FCPA to Mark Hurd’s very public departure for (alleged) sexual harassment to the recent announcement, reported in the WSJ, that the SEC is investigating Hurd in, ‘a broad inquiry that includes an examination of a claim the former chief executive officer shared inside information.” However we will focus on the FCPA matter which involves the alleged payment of an approximately $10.9 bribe to obtain a $47.3 million computer hardware contract with the Moscow Prosecutor’s Office. 

In an April 15, 2010, WSJ article, Mr. Dieter Brunner, a bookkeeper who is a witness in the probe, said in an interview that he was surprised when, as a temporary employee of HP, he first saw an invoice from an agent in 2004. “It didn’t make sense,” because there was no apparent reason for HP to pay such big sums to accounts controlled by small-businesses such as ProSoft Krippner, Mr. Brunner said. Mr. Brunner then proceeded to say he processed the transactions anyway because he was the most junior employee handling the file, “I assumed the deal was OK, because senior officials also signed off on the paperwork”.

Why didn’t HP self report? 

The WSJ article reported that by December 2009, German authorities traced funds to accounts in Delaware and Britain. In early 2010, German prosecutors filed a round of legal-assistance requests in Wyoming, New Zealand and the British Virgin Islands, hoping to trace the flow of funds to new sets of accounts. Further, HP knew of the German investigation by at least December 2009, when police in Germany and Switzerland presented search warrants detailing allegations against 10 suspects. The New York Times, in an article dated April 16, 2010, reported that three former HP employees were arrested back in December 2009 by German prosecutors. Although it was unclear from the WSJ article as to the time frame, HP had retained counsel work with prosecutors in their investigation. Apparently, since the SEC only announced it had joined the German and Russian investigation last week, HP had not self-disclosed the investigation or its allegations to the US Department of Justice (DOJ) or SEC. 

Where were the SEC and DOJ? 

On April 16, 2010, the FCPA Professor wondered in his blog if it was merely coincidence that a few weeks ago the US concluded a Foreign Corrupt Practices Act (FCPA) enforcement action against the Daimler Corporation, an unrelated German company, for bribery and corruption in Russia and now it is German and Russian authorities investigating a US company for such improper conduct in Russia. The Professor put forward the following query: is such an investigation “Tit for tat or merely a coincidence?” And much like Socrates, he answered his own question with the musing “likely the later”. The WSJ LawBlog noted in its entry of April 16, 2010, that it would be somewhat unusual for the DOJ or SEC to stand by and watch European regulators conduct a sizable bribery investigation of a high-profile US company; phrasing it as “It’s like asking a child to stand still after a piñata’s been smashed open”.

In September, the WSJ reported that the HP bribery probe has widened and HP, itself, has announced that investigators have “now expanded their investigations beyond that particular transaction.” This original investigation pertained to an investigation of allegations that HP, through a German subsidiary, paid bribes to certain Russian officials to secure a contract to deliver hardware into Russia. The contract was estimated to be worth approximately $44.5 million and the alleged bribes paid were approximately $10.9 million. In a 10-Q filing made with the SEC, HP stated that the investigation has now expanded into transactions “in Russia and in the Commonwealth of Independent States sub region dating back to 2000.” The WSJ noted that US public companies, such as HP, are only required to report FCPA investigations in SEC filings if they “are material for investors.” 

4. Team Inc.- no de minimis exception in FCPA.  

As reported by the FCPA Professor, in August 2009, Team disclosed that an internal investigation conducted by FCPA counsel “found evidence suggesting that payments, which may violate the Foreign Corrupt Practices Act (FCPA), were made to employees of foreign government owned enterprises.” The release further noted that “[b]ased upon the evidence obtained to date, we believe that the total of these improper payments over the past five years did not exceed $50,000. The total annual revenues from the impacted Trinidad branch represent approximately one-half of one percent of our annual consolidated revenues. Team voluntary disclosed information relating to the initial allegations, the investigation and the initial findings to the U.S. Department of Justice and to the Securities and Exchange Commission, and we will cooperate with the DOJ and SEC in connection with their review of this matter.” 

There is no de minimis exception found in the FCPA there are books and records and internal control provisions applicable to issuers like Team. Thus, even if the payments were not material in terms of the company’s overall financial condition, there still could be FCPA books and records and internal control exposure if they were misrecorded in the company’s books and records or made in the absence of any internal controls. 

In its 8K, filed on January 8, 2010, Team reported “As previously reported, the Audit Committee is conducting an independent investigation regarding possible violations of the Foreign Corrupt Practices Act (“FCPA”) in cooperation with the U.S. Department of Justice and the Securities and Exchange Commission. While the investigation is ongoing, management continues to believe that any possible violations of the FCPA are limited in size and scope. The investigation is now expected to be completed during the first calendar quarter of 2010. The total professional costs associated with the investigation are now projected to be about $3.0 million.” 

So the FCPA Professor posed the question: 

A $3 million dollar internal investigation concerning non-material payments made by a branch office that represents less than one-half of one percent of the company’s annual consolidated revenues?” 

And his answer: “Wow!” 

In August, 2010, when disclosing its interim financial results for this year, Team reported, “The results of the FCPA investigation were communicated to the SEC and Department of Justice in May 2010 and the Company is awaiting their response. The results of the independent investigation support management’s belief that any possible violations of the FCPA were limited in size and scope. The total professional costs associated with the investigation were approximately $3.2 million.” 

So $50,000 in (possibly) illegal payments equate to over $6 million investigative costs, so far. 

5. ALSTOM-Arrests in the Board Room. 

As reported by the FCPA Blog, the UK Serious Fraud Office reported in dramatic fashion the arrest of three top executives of French industrial giant ALSTOM ‘s British unit. The three ALSTOM Board members were suspected of paying bribes overseas to win contracts. The SFO Press Release stated that “[t]hree members of the Board of ALSTOM in the UK have been arrested on suspicion of bribery and corruption, conspiracy to pay bribes, money laundering and false accounting, and have been taken to police stations to be interviewed by the Serious Fraud Office.” 

According to the release, search warrants were executed at five ALSTOM businesses premises and four residential addresses. The operation, involving “109 SFO staff and 44 police officers” is code-named “Operation Ruthenium” and centers on “suspected payment of bribes by companies within the ALSTOM group in the U.K.” According to the release, “[i]t is suspected that bribes have been paid in order to win contracts overseas.” 

ALSTOM released a statement which said: 

Several Alstom offices in the United Kingdom have been raided on Wednesday 24 March by police officers and some of its local managers are being questioned. The police apparently executed search warrants upon the request of the Swiss Federal justice. Alstom has been investigated by the Swiss justice for more than 3 years on the motive of alleged bribery issues. Within this frame, Alstom’s offices in Switzerland and France have already been searched in the past years. Alstom is cooperating with the British authorities. 

While not an FCPA investigation, this is one of the first cases where arrests were made of Board members. With the April 1 implementation date for the UK Bribery Act, we would anticipate a much more robust and aggressive enforcement by the UK SFO. 

We are indebted to our fellow bloggers, the FCPA Blog and the FCPA Professor for providing up to date and excellent reviews of many of the Top 10 investigations of 2010. If you did not review their sites daily in 2010, you should do so in 2011. 

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, 2010

July 14, 2010

TOP 3 FCPA CASES OF 2010 PART II-(DING DONG) AVON CALLING

This is the second installment of our three part series on the Top 3 Foreign Corrupt Practices Act (FCPA) matters of 2010 to date and their significance for the FCPA compliance professional. In Part I we focused on the Gun Sting matter. Now we turn our attention to the Avon bribery scandal in China. 

As early as October 2008, Avon reported, in a Statement of Voluntary Disclosure, that it was investigating an internally reported allegation by an undisclosed whistleblower that corrupt payments had been made in its China operations. These allegations claimed that certain travel, entertainment and other expenses may have been improperly incurred. Although the details of the Avon case have not been disclosed, direct selling was not allowed in China under a law passed in 1998. The National Law Review reported that Avon was able to secure permission in late 2005 to begin direct selling on a limited basis. Later the Chinese government issued direct-selling regulations and granted Avon a broader license in February 2006 to make such sales.

In its 2009 Annual Report, Avon noted that the internal investigation and compliance reviews, which started in China, had now expanded to its operations in at least 12 other countries and was focusing on reviewing “certain expenses and books and records processes, including, but not limited to, travel, entertainment, gifts, and payments to third-party agents and others, in connection with our business dealings, directly or indirectly, with foreign governments and their employees”. The FCPA Professor, citing the Wall Street Journal, reported that Avon suspended four employees, including the

President, Chief Financial Officer and top government affairs executive of Avon’s China unit as well as a senior executive in New York who was Avon’s head of Internal Audit.

 One of the significant pieces of information to come out of the Avon matter is the reported costs as reported in the 2009 Annual Report the following costs have been incurred and are anticipated to be incurred in 2010:

Investigate Cost, Revenue or Earnings Loss
Investigative Cost (2009) $35 Million
Investigative Cost (anticipated-2010) $95 Million
Drop in Q1 Earnings $74.8 Million
Loss in Revenue from China Operations $10 Million
Total $214.8 Million

Marketwatch also reported that after these additional investigations were made public Avon’s stock prices fell by 8%. Lastly, in addition to the above direct and anticipated costs and drop in stock value, the ratings agency Fitch has speculated about the possibility of a drop in Avon’s credit ratings. In a June 1 Press Release, Fitch noted that not only could the above listed investigative costs come out of Avon’s ordinary cash flow, thereby putting a strain on the company, but that Fitch would expect companies such as Avon to make every effort to comply during an agreed upon deferred prosecution period with the Department Of Justice (DOJ) given the severity of an indictment. 

An indictment for FCPA violation(s) would be viewed as ‘Event Risk’, a term used by Fitch to describe the risk of a typically unforeseen event to the analyst which, until the event is explicit and defined, is excluded from existing ratings. An indictment would be an externally triggered event that would generate a rating review based on materiality and impact. 

But what does all of this mean for the Chief Compliance Officer sitting in his office in the US? It should mean quite a bit. There are several lessons from which you can learn and immediately implement in your FCPA compliance program if you have not previously done so. 

But what does all of this mean for the Chief Compliance Officer sitting in his office in the US? It should mean quite a bit. There are several lessons from which you can learn and immediately implement in your FCPA compliance program if you have not previously done so. 

1.     Who is a “foreign governmental official”? China poses a major challenge for US companies trying to comply with the law. The DOJ has consistently interpreted the FCPA as extending to any employee working for a state-owned business. Further, in a communist country, the DOJ has taken this interpretation a step further by opining that all employees are state employees and therefore a foreign governmental official. This means that from top to bottom, all persons in China are covered by the proscriptions of the FCPA. This interpretation has never been tested in a US court but it puts the broad swaths of the Chinese economy directly under the FCPA. Couple this with the pressure felt by foreign companies to sponsor trips by Chinese regulators, who do not seem to be shy in asking for perquisites, and you have a situation which is ripe for a FCPA violation. 

2.     Travel, Gifts and Entertainment under the FCPA. The FCPA includes an affirmative defense for payments to officials related directly to “the promotion, demonstration, or explanation of products or services” that are “reasonable and bona fide” 15 U.S.C. §§ 78dd-1(c)(2)(A) and 78dd-2(c)(2)(A). That defense is loaded with uncertainty and very difficult for companies to safely use. It may well be that Avon provided trips to the US for the Chinese Regulators with regulatory oversight for Avon’s China operations, or gifts and entertainment which did not fall under the FCPA exemption. If so, the FCPA compliance professional should review the company policy on such matters.  

3.     Internal Enforcement of Company FCPA Compliance Policy. One of the employees suspended was the (former) head of Internal Audit. In addition to a strong FCPA compliance policy, a company should continually monitor its compliance program, through a strong internal audit program, to use  as a first line of defense to not only prevent FCPA violations before they occur but also detect FCPA compliance violations.  

A key ‘best practices’ FCPA compliance program component is to utilize internal audit to monitor for FCPA compliance issues on a regular basis to not only assess compliance but to also identify anything which warrants further investigation. Taken a step further, a continuous controls monitoring program can assist a company to identify unusual expenses, budgeted items, or any other event which is outside an established norm and Red Flag such expense, item or event for further investigation.

All of the facts of the Avon matter should be carefully studied by the Chief Compliance Officer of any company doing business in China. The case stands for the proposition that a company should not only have a robust FCPA compliance policy in place but that it must continually monitor the policy to ensure compliance.

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, 2010

May 3, 2010

What is the Cost of FCPA Compliance? Or what is the cost of non-compliance?

How do you measure the cost of poor performance? In the baseball world how do you measure the cost of the Houston Astros abysmal April and equally poor start in May, which is projected to lead to a 50-108 season record? One measure is the number of people who pay to come out to the ballpark. As reported in the May 2nd edition of the Houston Chronicle, the Astros home attendance is down 2,640 which translates into a per game revenue loss of up to $660,000. That works out to a full season loss of revenue of up to $5,436,000. This, of course, assumes that the drop in attendance is based directly on poor performance and not other factors such as the drop in disposable income due to the economy or some other factor. But is this the sole measure of the Astros loss?

In the Foreign Corrupt Practices Act (FCPA) world, there can be a more direct relationship of the costs to a violation or even an investigation. For instance, a former investigation into a Nigerian bribery case involving bribe payments of up to $132 million could lead to fines and disgorgement penalties of more than $1.2 billion. (For a more complete discussion, see blog posting here.) These fines and penalties do not include any costs for investigations, legal or accounting fees, other professional fees or drop in stock value associated with an investigation.

All of this brings us to ‘Ding Dong Avon Calling’ and the bribery probe of its China operations. As reported by Aruna Viswanatha, in MainJustice, on April 30 and Ellen Byron, in the Wall Street Journal, on May 1, Avon has reported its costs for the alleged scandal which has engulfed the company. The investigation has now expanded from China to four other (unidentified) business units. CEO Andrea Jung is reported as saying, in an April 30 conference call with investors, “No conclusions can be drawn at this time,” regarding the investigations. However, what Avon did report is some of its FCPA investigative costs to date, anticipated FCPA investigative costs, loss of revenue in China and loss in first-quarter earnings.

The expenses, both anticipated and occurred to date, and their earnings loss box score is as follows (to-date): 

Investigate Cost, Revenue  or Earnings Loss  
Investigative Cost (2009) $35 Million
Investigative Cost (anticipated-2010) $95 Million
Drop in Q1 Earnings $74.8 Million
Loss in Revenue from China Operations $10 Million
Total $214.8 Million

While the amount of the alleged bribery, or other corruption, has not yet been reported, MainJustice reported that the investigation is looking into “travel, entertainment, and gift expenses”. It is difficult to believe that the $$ value of the bribes are anywhere close to the above mentioned investigation cost, revenue or earnings loss. The WSJ reported that Avon will overhaul its approach to sales in China, moving towards a direct selling approach, over the next 18 months. This certainly sounds like Avon is moving away from agents and distributors, the bane of many other US companies doing business abroad.

The WSJ also reported that the Avon investigation has expanded into its business practices in countries “selected to represent” each of its overseas regions. With slightly less than three-quarters of Avon’s overall company revenue coming from outside the US, it may well be that the Department of Justice (DOJ) will want a more comprehensive review of the company’s business practices worldwide, rather than simply “selected” business practices in “selected” countries. If I were Avon, I know I would want to do so, if not for the DOJ, but for my company.

How do you measure the cost of FCPA compliance? Put another way, can your company afford not to be FCPA compliant? What will the costs be if there are allegations of bribery and corruption in your company? Will the investigative costs exceed $100 million as they may well do in Avon’s case? Will your fine, penalty and any profit disgorgement exceed $550 million as happened with Halliburton or simply be in the $330-$340 million range as with its former Joint Venture partners? If you agree to a Corporate Monitor what will be that cost? As reported by Chris Matthews, in MainJustice on March 18, 2010, US District Judge Ellen Segal Huvelle raised the following spectre regarding Corporate Monitors during the Innospec Deferred Prosecution Agreement (DPA) and guilty plea hearing:

It’s an outrage, that people get $50 million to be a monitor,” Huvelle said during a hearing in Washington, D.C., to approve a guilty plea for Innospec Inc., an international specialty chemicals company with nearly 1,000 employees. “I’m not comfortable, frankly, signing off on something that becomes a vehicle for someone to make lots of money.”

This could lead to an Avon Box Score of costs which could read:

Cost Amount
Pre-DPA Investigative Costs $95 million???
Pre-DPA Revenue and Earnings Loss $84 million???
Penalty and Profit Disgorgement $100 million???
Monitor Cost $50 million???
Total How Many Hundreds of $$$ Millions?

So will the Astros lose 108 this year or is there something they can do about it. Equally important, what will be the cost to your company for FCPA (non) compliance and are you willing to risk it…or are you willing to do something to prevent it.

For a clip of a classic “Ding Dong, Avon Calling” TV commercial, 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, 2010

The Rubric Theme. Blog at WordPress.com.

Follow

Get every new post delivered to your Inbox.

Join 4,830 other followers