FCPA Compliance and Ethics Blog

October 20, 2014

Internal Controls Outside the US – Part IV

NavigatingThis post will conclude a short series I have presented on the issue of internal controls outside the US. I want to conclude by raising some ways in which a compliance professional can work to implement internal controls in a multi-national organization. As with my entire series on internal controls, I rely on internal controls expert Henry Mixon for guidance on this topic. 

Mixon advises that the first step is to convert your company’s Foreign Corrupt Practices Act (FCPA) risks into internal control objectives. The internal control objectives are then given to each business unit with instructions to develop controls, which meet the objectives. This process should allow more of a fine tuning approach within existing systems than the development of specific controls by corporate which all business units must adopt and will give the business unit a sense of buy-in and participation in the process.

Mixon provided an example of how the process might work in the situation where the FCPA risk is that a third party representative may be paid for an invoiced amount before that third party representative has gone through your company’s full third party approval process. Mixon began by noting that your control objective is that internal controls should be in place to ensure that no vendors are added to the vendor master file until the vendor has been approved. If your company has a sophisticated ERP system such as SAP where checks are generated using the vendor master file and signed by the computer, this control objective may be met by adding a field to the vendor master file in which inserts the date the vendor is approved and by programming such a requirement the vendor information cannot be inserted into the check to pay the vendor unless the designated fields are populated. There would also be manual controls over the input of the date to ensure the data is not entered inappropriately. These internal controls would translate into form for changes to the vendor master file which is initiated by the person in charge of vendor due diligence and requires a ‘second set of eyes’ requiring sign off by a second person, such as the controller. Through this mechanism you have created a primary control through your third party approval process and validated that process if a change is made.

What if your location or business unit involved does not have a sophisticated ERP system such as SAP, for instance at another location QuickBooks is used? Mixon suggests that the control objective could be satisfied by using a similar form for changes to the vendor master file combined with the requirement that a report of all changes are printed and submitted to both check signers, along with the applicable approved vendor change request.

One of the banes of any compliance practitioner is the push back they inevitably receive when they attempt to institute something new or different. The same can be true of internal controls. What happens when the compliance function receives push back and will be told the controls are too burdensome and also make operations less efficient? I inquired from Mixon how he might suggest this situation be dealt with going forward. Fortunately for us, this is something that Mixon has observed many times and is very familiar with the issue as many employees see internal controls only as an added burden. Moreover, many business development types will raise the hue and cry that internal controls prevent them from effectively running the business. Finally, there are many groups in any company that may well say that a re-work of internal controls will cost too much money.

One of the areas available to a compliance professional is benchmarking from other company’s compliance experiences. However this can be expanded into solid presentations about why it is important to assess and mitigate FCPA risks using your corporate peers that have been the subject of an FCPA enforcement action. This is some of the best sources of information a compliance practitioner can avail his or herself of to provide good insight into why it was never expected that the company would be subject to FCPA enforcement and insight into the extreme disruption, cost, and anxiety which accompanied the enforcement actions.

Mixon also advises that the premise is that the cost of controls should not exceed the benefits to be obtained, so it really comes down to internally selling a cost benefit analysis. If the selling is done after at least a basic risk analysis, Mixon believes that it should be relatively easy to obtain concurrence that certain risks must be mitigated and that the benefits exceed the expected costs. Furthermore, there are occasions where there are no costs associated with improving controls. A good example is when re-alignment of duties using existing staff achieves an improved set of internal controls. Another example is when manual controls can be converted to electronic controls such that the only cost is the programming and re-training costs.

Another key factor, as with all FCPA compliance initiatives, is ‘Tone at the Top’. This means that you should meet with and present the case for FCPA-focused internal controls to your company’s Executive Leadership Team (ELT), Audit Committee of the Board or other appropriate group of senior executives. The presentation should include, with examples, the importance of identifying and mitigating the FCPA and fraud risks. Some of these might include the following:

  • Illustrating the examples of how the controls can prevent bribery as well as many other types of occupational fraud;
  • Illustrating that the controls needed are all sound business controls, nothing exotic or out of the ordinary;
  • With proper control design, it may be possible to eliminate some existing detect controls in favor of more useful preventive controls or even prescriptive controls;
  • As a result of your business changes and resulting changes in assessed risks, it may be that some procedures now being performed are no longer needed and the resources can be shifted to more necessary controls; and
  • It may be possible to build in more electronic controls, which can replace existing manual controls.

What if your company does an assessment of the internal controls over financial reporting as part of Sarbanes Oxley (SOX) compliance and that the Chief Financial Officer (CFO), or other appropriate corporate officer, annually certifies the internal controls are effective? How should such a situation be dealt with or conversely how might a compliance professional respond? 

Mixon believes that there are two primary reasons why the assessment under SOX is not sufficient for a Compliance Officer’s purposes. One is the scope of the SOX assessment and the second is the design of the SOX assessment. This means that the SOX process addresses only the internal controls over financial reporting, that is, the controls in place to prepare the financial statements for presentation to third parties. That process does not address the risks or the control needs with respect to FCPA. Mixon cited to the example of internal controls over disbursements, which may be evaluated as being effective if there is a three-way match of the approved purchase order, the vendor invoice, and the receiving report. Those controls do not address the risk that an agent may submit an invoice before the agent has been vetted and the invoice will be paid. It also does not address whether the agent’s invoice was reviewed for proper description of business purpose and for being consistent with the approved contract with the agent.

The second primary reason SOX certification of financial internal controls itself is not enough is the design criteria. SOX allows a materiality threshold. This means that operations outside the US may be excluded from scope due to materiality. It may also mean that some functions are operating below the financial internal controls level. Compliance professionals need to continually remind others that there is no materiality requirement in FCPA enforcement.

I hope that you have benefited from these posts on internal controls outside the US. I clearly believe that the price for noncompliance can easily be substantially greater than the cost to assess and implement good internal controls. But good FCPA internal controls are not some standalone protective measure. They can help to make a company run more efficiently as the internal controls that prevent FCPA violations are the same ones that prevent fraud in the workplace. So the presence of good internal controls saves money by preventing fraud. It is a business best practice to prevent fraud, which includes preventing corruption. I have long wondered about Ethisphere and its annual survey of the world’s most ethical companies because they seem to exceed the Standard & Poor’s (S&P) index of average profits and growth. What I have come to believe is that one of the keys ways such companies do seem to have better than average profitability is that they have better internal controls.

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

October 14, 2014

Steve Bartman and Internal Controls Outside the US, Part II

BartmanToday, we note that 11 years ago, Steve Bartman entered the Chicago Cubs Hall of Infamy. For every baseball fan, if there was ever a but for the grace of God, go thee moment the sad saga of Bartman is it. The Chicago Cubs, who at that point had not played in World Series appearance in 58 years were five outs away from going to the 2003 Fall Classic. Bartman interfered with a ball he thought was in foul territory on the left field line but was in fact playable and about to be caught by Left Fielder Moisés Alou. His interference allowed the at-bat to continue and the batter got a hit. The Cubs fell apart and lost the game. Bartman was escorted from Wrigley Field by security guards as bloodthirsty fans hurled beer cans and other debris at his head. The next day, he went into hiding—but not before he told the press that “I’ve been a Cub fan all my life and fully understand the relationship between my actions and the outcome of the game – I am so truly sorry from the bottom of this Cubs fan’s broken heart.” Bartman lives in hiding to this day. Why is it a but for the grace of God moment? Because probably every baseball fan in the universe would have done what Bartman did and interfere by catching the ball, or at least trying to catch it.

Bartman’s story provides the starting point for today’s post. Last week, in Part I of this three-part series on internal controls for US company-business units which are located outside the US, I discussed some of the reasons why there might be such differences and provided a framework for thinking through how to assess the risk they might pose a company subject to the Foreign Corrupt Practices Act (FCPA). The framework I introduced in Part I was a Location Risk Assessment; today, I will discuss how to perform this assessment. Once again, I will rely on internal controls expert Henry Mixon for guidance in this area.

It is incumbent that you need to review as much information as you can to understand the financial and operational structure of an entity and how the financial and operation structure outside the US is integrated with the corporate headquarters, or the US business unit’s financial and operation structure, if the foreign operation is part of a US business unit. Mixon suggested that you could begin with the Transparency International (TI) Corruption Perceptions Index (CPI) to garner a sense of the reputation of the country in which your business unit is located, as well as the CPI for all other countries in which the location either markets business or has current customers. Another area for inquiry or review is the scope of your operations at a location outside the US. This means you will need to consider your sales model, whether employee based or primarily using third party representatives. You will also need to consider if such third party representatives are coming into a commercial relationship with your company through your supply chain.

Other areas of inquiry, which could be considered, include whether your company’s finance and accounting staff produce financial statements that are integrated into the parent’s financial statements; whether your international business locations utilize a local bank account for local sales receipts as well as funds transfers from the US and whether the account has local check signers and whether dual signatures are required on the checks. You may also want to consider the extent to which local disbursements are made in local currency and, of course, is there a local petty cash fund?

As with many other areas around internal controls, it is important to consider the local Delegation of Authority (DOA) and whether it is consistent with your corporate DOA. Mixon suggested that some of the considerations regarding the local DOA should extend to which corporate or US business unit approvals are required for transactions initiated locally, such as: (1) Approval of vendor invoices, (2) Disbursements of funds, including wire transfers; (3). Execution of facilities leases; (4) Execution of contracts with agents; and (5) Approval of pricing and credit terms to customers and distributors. You should also review whether the local DOA provides appropriate segregation of duties at the local business unit level.

You should consider how sales of product are conducted. For example, is an inventory maintained at the local operation for shipment of customers? Are products drop shipped from US directly to the customers of the local operation? Are products drop shipped to distributors for delivery to the ultimate customer?

Hopefully you are already doing the above but you should review what is being done to determine if employees or local contractors who are local nationals have gone through your due diligence process so that they have been properly vetted to determine whether they are government officials in any capacity or are relatives of government officials. Along the lines of a more formal FCPA analysis you should review to see if there has been any investigation of alleged fraud, including FCPA violations, at the location and if so, what were the results of the investigation? In the area of customers, you should review with whom each international location does business to determine the extent to which its current customers are local government entities as well as the extent to which the location is pursuing sales activities for other local government entities.

If there has not been a sufficient assessment of controls, the compliance professional must then decide how to best determine whether the local controls are sufficient to satisfy the requirement of the FCPA and accurately reflect all transactions and prevent concealment of improper transactions. Mixon believes that some of these considerations would be an inadequate segregation of duties because the separation of responsibility for physical custody of an asset from the related record keeping is a critical control. In practice, this means that persons who can authorize purchase orders (Purchasing) should not be capable of processing payments (Accounts Payable). Further, the employee who prepares the deposit should not post the receipts to the customer accounts.

You should look to see if there is inappropriate access to assets. If there is internal controls should be created to provide safeguards for physical objects such as inventory and cash, restricted information, critical forms, and update applications. This means that an employee who only needs to view computer information should be restricted to Read and File Scan access and should not be granted Write and Create access. Moreover, controls should prevent the unauthorized removal of resale inventory and movable fixed assets from the premises.

It is not necessary to prove a bribe to have been paid in order to have an enforcement action against a company for violation of the internal controls provisions of the FCPA. In the recent Securities and Exchange Commission (SEC) enforcement action against Smith & Wesson, that was the situation. The lack of effective internal controls, not the payment of a bribe, was the basis for the civil enforcement action. This means that you should look to make certain the situation is not one of form over substance, where controls can appear to be well designed but still lack substance, as is often the case with required approvals.

Mixon said that such a situation could arise in several different scenarios. The first is where an account manager’s signature attests to the accuracy of the payroll voucher information, but if the account manager does not have assurance that the supporting time records are accurate, the approval process lacks substance. Other examples are where a supervisor who approves expense reports but routinely does not look at the supporting documentation; a Country Manager provides a true control as an approver; or where the Country Manager or the local Finance Manager has ability to conceal the true nature of transactions without detection by anyone else.

Another important area involves sales and compensation for the international business unit in question. On the sales side of the equation, Mixon suggested you review the three-year historical sales for the location and what are the budgeted sales for the upcoming year. This can give insight into the relative pressure on employees to grow the business and, accordingly, the possibility of an employee seeing a bribe as a good way to grow the business. The inquiries can lead to questions about compensation such as what is the sales incentive compensation plan for local sales personnel and for the Country Manager; as this inquiry gives insight into the possibility of personal benefit which might result from someone paying a bribe in order to win a contract which results in a large sales incentive compensation to the employee.

All of these reviews, questions, inquiries and analyses are designed to locate the pressure points involved in any company’s sales processes. This is because pressure is a key element of occupational fraud and the risk of fraud, including corruption, increases as the pressure increases. Since corruption is viewed as a subset of fraud, it might be a good time to review the Fraud Triangle, which lays out breeding ground for fraud in the corruption context:

  • Pressure which has financial implications, whether it be personal financial needs that are unmet or pressure to reach sales goals;
  • Rationalization – a fraud perpetrator always rationalizes that he / she is not a criminal and when committing fraud for personal benefit, the perpetrator intends to repay the money; when committing fraud for company benefit, the perpetrator rationalizes that the company really wants to meet its goals and that the perpetrator’s actions are in furtherance of the company’s goals; and
  • Opportunity – the perpetrator must be in a situation where the internal controls do not prevent the fraud and its necessary concealment.

Steve Bartman has never spoken publicly about the event to this day. There has been no catharsis for him like the Red Sox fans gave Bill Buckner. But in the FCPA universe for your operations outside the US, you do not have to be a Bartman. In Parts I & II of this series, I have reviewed what some of the risks might be in your international locations that you do not have in your US domestic operations. In Part III, I will discuss how to use the Location Risk Assessment as a tool to provide a structured approach to establishing effective internal controls.

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

October 13, 2014

Ringo, Sir Paul and an Effective Compliance Program

Paul McCartneySometimes the universe converges in ways that are beyond my simple comprehension. This past weekend was one of them. It began a few months ago when I saw an advertisement from StubHub that showed Ringo Starr playing in Houston on October 10 and Sir Paul McCartney playing in New Orleans on October 11. I figured if the two surviving members of the greatest rock and roll band in the history of the world were going to play on two consecutive nights it was a sure sign from the Oracle of Rock ‘N Roll that I was intended to attend both, lest I tempt a fate worse than going against an entity nearly as powerful as the Oracle of Delphi. Moreover, the Friday concert coincided with the birthday of my little sister who happened to be in town and one of the planets biggest Beatles fans, it made the convergence complete. Ringo Starr

I also learned two completely new and unrelated facts this weekend. The first is that a native of Liverpool, England, is called a ‘Scouser’. That comes from my Liverpudlian friend Pam, who also introduced me to the Liverpool Football Club. The second is that my wife is a closet Mr. Mister uber fan, who rocked out as a teenager to this group in the early days of MTV. On reflection that is perhaps the more odder convergence.

While there is clearly a reason Ringo Starr tours with true musical all-stars and Sir Paul McCartney has been raised to the peerage for his musical prowess, in many ways the Ringo Starr concert was the bigger revelation. I had wondered how Ringo would fill out an entire concert. He did it by surrounding himself with musicians fabulous in their own right. They included: Steve Lukather, former lead singer from Toto on vocals, lead and rhythm guitar; Gregg Rolie, former keyboardist from Santana and Journey on vocals, organ, keyboards; Richard Page, former lead singer from Mr. Mister, on vocals and bass guitar; and finally, best and certainly not least, Todd Rundgren on vocals, lead and rhythm guitar, bass guitar, percussion, harmonica and, occasionally, even keyboards.

So in addition to Ringo singing his standards of Photograph, It Don’t Come Easy, Yellow Submarine and (of course) With a Little Help From My Friends. We also got to hear songs first released by Santana, Toto, Mr. Mister and some great Todd Rundgren hits. The group clearly loved playing and jamming with each other. Further, these other groups’ songs were great fun to hear and as they may never reform, I would not otherwise have the chance to hear them performed lived.

Sir Paul McCartney. You really do not have to say much more. His concert did not exceed my expectations because they were about as high as expectations could have been. He seriously rocked out for over three hours, playing everything from the earliest Beatles songs up to a ballad for his latest wife. I cannot remember ever attending a concert where everyone one in attendance knew the words to every song but we all did and we all sung them all the way through the entire show.

What is the compliance angle to all of this? Just as there is more than one way to put on a great concert, there is more than one way to have an effective compliance program. This continual message from the Department of Justice (DOJ) came again earlier this month through remarks by Assistant Attorney General for the Criminal Division, Leslie R. Caldwell, at the 22nd Annual Ethics and Compliance Conference, where she made clear that while the FCPA Ten Hallmarks of an Effective Compliance Program is one set of guidelines for an effective compliance program, there is no “one-size fits all” compliance program. She laid out another way to think through, review and analyze your compliance program. 

  1. High-level commitment. A company must ensure that its directors and senior management provide strong, explicit, and visible commitment to its corporate compliance policy. Stated differently, and again, “tone from the top.”
  1. Written Policies. A company should have a clearly articulated and visible corporate compliance policy memorialized in a written compliance code. Again, employees need to know what to do–or not do–when faced with a tough judgment call involving business ethics. Companies need to make that as easy as possible for their employees.
  1. Periodic Risk-Based Review. A company should periodically evaluate these compliance codes on the basis of a risk assessment addressing the individual circumstances of the company. Companies change over time through natural growth, mergers, and acquisitions.
  1. Proper Oversight and Independence. A company should assign responsibility to senior executives for the implementation and oversight of the compliance program. Those executives should have the authority to report directly to independent monitoring bodies, including internal audit and the Board of Directors, and should have autonomy from management. Compliance programs needed to be funded; they need to have resources. And they need to have teeth and respect within the company.
  1. Training and Guidance. A company should implement mechanisms designed to ensure that its compliance code is effectively communicated to all directors, officers, employees. This means repeated communication, frequent and effective training, and an ability to provide guidance when issues arise.
  1. Internal Reporting. A company should have an effective system for confidential, internal reporting of compliance violations. I know that many companies have multiple mechanisms, which is good.
  1. Investigation. A company should establish an effective process with sufficient resources for responding to, investigating, and documenting allegations of violations. What this means on the ground will depend on the company. A sophisticated multi-national corporation obviously will be expected to have more resources devoted to compliance than a small regional company.
  1. Enforcement and Discipline. A company should implement mechanisms designed to enforce its compliance code, including appropriately incentivizing compliance and disciplining violations. Further, the response to a violation must be even-handed. People watch what people do much more carefully than what they say. When it comes to compliance, you must both say and do.
  1. Third-Party Relationships. A company should institute compliance requirements pertaining to the oversight of all agents and business partners. This cannot be emphasized strongly enough.
  2. Monitoring and Testing. A company should conduct periodic reviews and testing of its compliance code to improve its effectiveness in preventing and detecting violations. Kick the tires regularly. As I said, compliance programs must evolve with changes in the law, business practices, technology and culture.

Caldwell also emphasized that as important as the compliance program itself; the implementation is also reviewed and evaluated by the DOJ. When the DOJ investigates a case, they look at the messages about compliance that are given to employees; they look at what employees are told in their day-to-day work. This means the DOJ will look at emails, chats, and recorded phone calls. They will interview witnesses about the messages they received from their supervisors and management to determine if they received messages about compliance, or about making money at all costs.

Another consideration for the DOJ is incentives. The DOJ will examine the incentives that a company provides to encourage compliant behavior – or not. This means that if a company is actually encouraging compliance, if its values are to be ethical and within the law, this message must be conveyed to employees in a meaningful way. If not, it is likely that the DOJ will not view the compliance program as credible. Interestingly, Caldwell said that sometimes the effective implementation of a compliance program means standing apart from the other companies in your industry.

Just as Ringo and Sir Paul ably demonstrated, there is more than one way to put on a great concert. They both assessed their strengths and weaknesses and used that information to put great bands around them illustrated their strengths. The same is true in the world of Foreign Corrupt Practices Act (FCPA) compliance. The key is to review and assess your compliance risks and then manage them. And, as always, Document, Document, and Document whatever you do so that if a regulator comes knocking, you can demonstrate evidence of the above.

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

 

 

 

October 2, 2014

The Mitford Sisters and the Compliance Audit

Mitford SistersDeborah Cavendish died last week. She was the last surviving member of an extraordinary group of women known as the ‘Mitford Sisters’. They were six daughters of David Freeman-Mitford, the 2nd Baron Redesdale and the former Sydney Bowles. The six had about as varied lives as one could possibly have from six different yet related siblings. Nancy (1904-73) became an author and wrote “The Pursuit of Love” and “Love in a Cold Climate.” Pamela (1907-94), who grew up wanting to be a horse, married a horseman who became a physicist. Diana (1910-2003) married Britain’s fascist leader Oswald Mosley, in the presence of Hitler and Joseph Goebbels. Unity (1914-1948) fell in love with Hitler and was Eva Braun’s rival for his affections; she died a decade after her attempted suicide with the bullet still in her head. Jessica (1917-96) was a communist. This did not prevent her from eloping with Churchill’s nephew and moving to the United States, where she penned “The American Way of Death” and other books. Deborah developed a passion for chickens and later married Andrew Cavendish, who became the Duke of Devonshire, making Deborah, the Duchess of Devonshire.

Deborah’s major accomplishment was to adapt the Duke ancestral home of Chatsworth into self-sustaining family business. She kept up a personal and active involvement in this project for nearly 40 years, until her husband died and she became the Dowager Duchess. Today, Chatsworth is one of the most visited sites in England.

I thought about Deborah, her remaking of Chatsworth and how she and her sisters remade themselves from the fairly-tale princess lives they grew up with when I read a recent article in the Red Flag Group’s Compliance Insider, September-October issue, entitled “Rethinking the typical audit”, by Georgia White. The piece recognized that the standard financial audit clause may be of little use to the compliance practitioner but it can be reworked “to include proactive compliance obligations which can be an effective and valuable way to positively manage relationships with distributors and resellers.” Some of the reasons for typical audit clauses with such parties are disfavored and were identified as “insufficiently tailored and poorly defined” or such audit clauses have some type of “catch-all” provision which allows a company to audit more than simply its relationship with a distributor or reseller. Such audit clauses were noted to “represent little value for both the client and the business partner.”

Compliance Audit Clause

The first focus of the article was that “Compliance audits should be aimed at engaging business partners to participate in compliance initiatives pro-actively, whether by way of interview or discussion, integrity circles or forums, or healthy checks or periodic review” all supplemented by occasional transaction sampling. In other words, you must do the work required in managing the relationship after the contract is signed or Step 5 in the Five Step lifecycle management of third parties. The article suggested the following compliance audit clause, “In addition to maintaining proper records and accounts in relation to Distributor/Reseller’s use of product X, Distributor/Reseller will participate in compliance health checks and periodic reviews, and attend integrity circle and forums on a regular basis as required by Supplier Y. In the event of an allegation of misconduct, upon seven (7) days written notice Supplier Y (or its authorized agent)may conduct an inspection and audit all relevant facilities and records of Distributor/Reseller to verify compliance with obligations under this Agreement. Such audit is to be conducted in business hours at Supplier Y’s own expense and in such a manner as not to unreasonably interfere with Distributor/Reseller’s normal business activity.”

Getting buy-in from business partners

The piece suggests that in this manner of pro-actively engaging your Distributor/Reseller you can help maintain “the integrity of the relationship” and keep “open and transparent lines of communication.” While it may be easier to include such a clause with a new Distributor/Reseller; you may face a challenge with such a relationship which has been long standing. However for an effective Distributor/Reseller to be maintained, the author believes that everyone must be treated equally (the Fair Process Doctrine in play) as “compliance audits should apply to new and existing partners alike.” The key is communication by educating your Distributor/Reseller base “on the value of this kind of proactive exchange on compliance issues during business-planning sessions.” In other words, set expectations by talking to your business partners about why the compliance audit is necessary and, more importantly, have them understand the “risks associated with product diversion and unethical behaviour.”

When should the audit clause be added?

The piece takes on another touchy subject in audit clauses which is timing by stating, “To maintain positive relationships with existing business partners it is important to consider the timing of any proposed changes to existing contractual provisions.” However White provided some timing points for initiating this discussion.

  • Contract renewal cycle. If such a discussion is brought up during the regular renewal cycle you certainly should have good argument about such programs under a Foreign Corrupt Practices Act (FCPA) best practices compliance program. The debate about whether distributors were covered was ongoing until a couple of years ago so many companies may not have considered auditing such relationships. Moreover, White notes that if you raise the issue during a renewal cycle, “business partners are less likely to invoke suspicion that is a ‘targeted’ requirement” you are aiming only at them.
  • Annual business planning sessions. Such meetings usually entail an overall strategy component so White believes it is a good time to bring up the issue in the context of your company’s overall anti-corruption compliance efforts. You should have the opportunity to “discuss best-practice strategy and introduce the possibility of proactive compliance auditing for the relationship going forward.” The more you can focus on the ‘partner’ nature of the compliance obligation the more this should resonate with your Distributor/Reseller.
  • Company-wide annual meetings with Distributor/Resellers. Here White suggests that if you bring all of your Distributor/Resellers together and announce the auditing requirement, you may be able to demonstrate that auditing is now a system wide requirement. She believes “The chance of buy-in is increased if it is perceived that other competitors are already actively engaging with you in this manner.”
  • White suggests, particularly if you are in a high risk environment or need to institute such an audit right sooner rather than later, to negotiate over audits rights. She suggests “consider introducing the proposed change in tandem with a benefit that is being rolled out to the business partner.” I would add that you could also sweeten up the pot.

From the overall tone of White’s article, the key seems to communication. Communication can be used to show that adding and then invoking a compliance audit clause is not necessarily a negative outcome. But more than communication with your Distributor/Resellers is the concept from the Fair Process Doctrine; that is, if the process is fair, people and business partners may be more willing to accept a perceived negative outcome. This will go a long way to alleviating fears from Distributor/Resellers that they are being targeted for some nefarious reason or worse, that your company may be using the information obtained in a compliance audit to drive down the commercial value of the relationship.

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

October 1, 2014

Creation of Yosemite and Putting Compliance at the Center of Strategy

YosemiteOn this day in 1890, an act of Congress created Yosemite National Park, home of such natural wonders as Half Dome and the giant sequoia trees. Environmental trailblazer John Muir (1838-1914) and his colleagues campaigned for the congressional action, which was signed into law by President Benjamin Harrison.

In 1889, John Muir discovered that the vast meadows surrounding Yosemite Valley, which lacked government protection, were being overrun and destroyed by domestic sheep grazing. Muir and Robert Underwood Johnson, a fellow environmentalist and influential magazine editor, lobbied for national park status for the large wilderness area around Yosemite Valley. With this persuasion, Congress set aside over 1,500 square miles of land for what would become Yosemite National Park, America’s third national park. In 1906, the state-controlled Yosemite Valley and Mariposa Grove came under federal jurisdiction with the rest of the park to create the Yosemite that we know today. It clearly was a triumph for Muir and Johnson but more so for the American people.

I recently read an article in the Harvard Business Review (HBR) that seemed to draw inspiration from the actions of Muir and Johnson. The article by Frank Cespedes, entitled “Putting Sales at the Center of Strategy”, discussed how to connect up management’s new sales plans with the “field realities your salespeople face.” Referencing the well-known Sam Waltonism that “There ain’t many customers at headquarters”; Cespedes believes that “If you and your team can’t make the crucial connections between strategy and sales, then no matter how much you invest in social media or worry about disruptive innovations, you may end up pressing for better execution when you actually need a better strategy or changing strategic direction when you should be focusing on the basics in the field.”

The problem is usually clear. Senior management and the C-Suite make clear their commitment to doing business ethically and in compliance with anti-corruption laws such as the Foreign Corrupt Practices Act (FCPA). The company even has a best practices compliance. But the problem is that the installation or enhancement of a compliance regime is usually perceived as a ‘top-down’ exercise. The reality of the employee base that must execute the compliance strategy is not considered. Even when there are comments, it is derisively characterized as ‘push-back’ and not taken into account in moving the compliance effort forward. I thought Cespedes piece had some great insights for the compliance practitioner so borrowing from his four-point process, I will rework it for a compliance professional.

Communicate the Strategy

It can be difficult for an employee base to implement a strategy that they do not understand. Even with a company wide training rollout, followed by “a string of e-mails from headquarters and periodic reports back on results. There are too few communications, and most are one-way; the root causes of underperformance are often hidden from both groups.” Here Cespedes’ insight is that clarification is a leadership responsibility and in the compliance function that means the Chief Compliance Officer (CCO) or other senior compliance practitioner. Moreover, if the problem is that employees do not understand how to function within the parameters of the compliance program, then there is a training problem and that is the fault of the compliance department. I once was subjected to a PowerPoint of 268 slides, which lasted 7.5 hours, about my company’s compliance regime. To say this was worse than useless was accurate. The business guys were all generally asleep one hour into the presentation as we went through the intricacies of the books and records citations to the FCPA. The training was a failure but it was not the fault of the attendees. If your own employees do not understand your compliance program that is your fault.

Continually improve your compliance productivity

I thought this point was insightful. Cespedes talked about incentivizing your sales force. Why not do the same concepts around compliance? You can work with your Human Resources (HR) department to come up with appropriate financial incentives. Many companies have ad hoc financial awards, which they present to employees to celebrate and honor outstanding efforts. Why not give out something like that around doing business in compliance? Does your company have, as a component of its bonus compensation plan, a part dedicated to FCPA compliance and ethics? If so, how is this component measured and then administered? There is very little in the corporate world that an employee notices more than what goes into the calculation of their bonuses. HR can, and should, facilitate this process by setting expectations early in the year and then following through when annual bonuses are released. With the assistance of HR, such a bonus can send a powerful message to employees regarding the seriousness with which compliance is taken at the company. There is nothing like putting your money where your mouth is for people to stand up and take notice.

Improve the human element in your compliance program

This is another area where HR can help the compliance program. More than ongoing assessment of employees for promotion into leadership positions, here HR can assist on the ground floor. HR can take the lead in asking questions around compliance and ethics in the interview process. Studies have suggested that certainly Gen Y & Xers appreciate such inquiries and want to work for companies that make such business ethics a part of the discussion. By having the discussion during the interview process, you can not only set expectations but you can also begin the training process on compliance.

However, this approach should not end when an employee is hired. HR can also assist your compliance efforts by tracking employees through their company career to identify those who perform high in any compliance metric. This can also facilitate the delivery on more focused compliance training to those who may need it because of changes on FCPA risk during their careers.

Make your compliance strategy relevant

Cespedes notes, “Most C-suite executives know these value-creation levers, but too few understand and operationalize the sales factors that affect them.” In the sales world this can translate into a reduction in assets to underperforming activities. This is all well and good but such actions must be coupled with an understanding of why sales might be underperforming in certain areas. In the compliance realm, I think this translates into two concepts, ongoing monitoring and risk assessment. Ongoing monitoring can allow you to move from a simple prevent mode to a more prescriptive mode; where you can uncover violations of your company’s compliance program before they become full blown FCPA violations. By using a risk assessment, you can take the temperature of where and how your company is doing business and determine if new products or service offerings increase your compliance risks.

Above all, you need to get out and tell the compliance story. Louis D’Amrosio was quoted for the following, “You have to repeat something at least 10 times for an organization to fully internalize it.” If there is a disconnect between your compliance strategy and how your employee base is implementing or even interpreting that strategy, get out of the office and go out to the field. But you need to do more that simply talk you also need to listen. By doing so, can help to align your company’s compliance strategy with both the delivery and in the field.

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

September 30, 2014

Discipline and Rigor in Your Internal Controls

DisciplineIn a recent New York Times (NYT) Op-Ed by David Brooks, entitled “The Good Order”, he discussed how routine can lead to creativity. He cited to the example of three well-known authors whose habits included the following. “Maya Angelou would get up every morning at 5:30 and have coffee at 6. At 6:30, she would go off to a hotel room she kept — a small modest room with nothing but a bed, desk, Bible, dictionary, deck of cards and bottle of sherry. She would arrive at the room at 7 a.m. and write until 12:30 p.m. or 2 o’clock.” Another example was John Cheever, who “would get up, put on his only suit, ride the elevator in his apartment building down to a storage room in the basement. Then he’d take off his suit and sit in his boxers and write until noon. Then he’d put the suit back on and ride upstairs to lunch.” Finally, there was the example of Anthony Trollope, who “would arrive at his writing table at 5:30 each morning. His servant would bring him the same cup of coffee at the same time. He would write 250 words every 15 minutes for two and a half hours every day. If he finished a novel without writing his daily 2,500 words, he would immediately start a new novel to complete his word allotment.” Brooks thesis for his piece seemed to be summed up by a quote from Henry Miller (of all people), “I know that to sustain these true moments of insight, one has to be highly disciplined, lead a disciplined life.” Sort of gives a whole new meaning to the word ‘discipline’.

However moving back to somewhat salacious concepts, I thought about those words in the context of internal controls around a Foreign Corrupt Practices Act (FCPA) compliance program. Brooks’ thoughts on building and maintaining order inform today’s post. In the area of internal controls, I believe it is incumbent to consider not only the most obvious risk areas for your internal controls but also the universe of potential transactions within the operations of a particular company. Once again relying on my friend and internal controls expert Henry Mixon I queried him about some of the other types of internal controls a company should consider around gifts, travel, business courtesies and entertainment.

One area that companies need to be mindful of is corporate checks and wire transfers, in response to falsified supporting documentation, such as check requests, purchase orders, or vendor invoices. Here Mixon believes that the Delegation of Authority (DOA) is a critical internal control. So, for example a wire transfer of $X between company bank accounts in the US might require approval by the Finance Manager at the initiating location and one officer. However, a wire transfer of $X to the company’s bank account in Nigeria, could require approval by the Finance Manager, a knowledgeable person in the Compliance function, and one officer. The key is that the DOA should specify who must give the final approval for such an expense.

I asked Mixon about the situation where checks drawn on local bank accounts in locations outside the US “off books” bank accounts, commonly known as slush funds. Petty cash disbursements in locations outside the US – the unique control issues regarding locations outside the US will be discussed in a future podcast. Some petty cash funds outside the US have small balances but substantial throughput of transactions. In this instance, Mixon said that the DOA should address replenishment of petty cash funds in countries outside the US, as well as approval of expense reports for employees who work outside the US, including those who travel from the US to work outside US.

Another area for concern is travel, the reason for this being that a company’s corporate travel department and independent travel agencies can buy tickets, hotel rooms, etc., for non-employees. Mixon noted that internal controls might be needed to ensure policies are enforced when travel for non-employees can be purchased through a corporate travel department or through independent travel agencies. As was demonstrated with GlaxoSmithKline PLC (GSK) in China, a company must not discount the risk related to abuse of power internally and collusion with independent travel agencies. Mixon advises that you should implement procedures to ensure compliance with your company policies regarding payment of travel and related expenses for third parties, for not only visits to manufacturing or job sites but also any compliance restrictions that might be in place.

An area for fraud, corruption and corporate abuse has long been Procurement cards or “P Cards”. Mixon cautions that if your company uses procurement cards, assume this to be a very high-risk area, not just for FCPA but also for fraud risk generally. Banks have made a great selling job to corporations for the use of P-Cards to help to facilitate “cash management” but, more often than not, they can simply be a streamlined way to allow embezzlement and misbehavior to go undetected. Here a control objective should be put in place along the lines of a written policy and procedures defining the acceptable and unacceptable use of company Procurement Cards, required forms, required approvals, documentation and review requirements.

An interesting analogy that Mixon used is that misbehavior, like water, seeks its own level. Mixon explained that this meant if the pre-approval process and strong controls over expense reports prevent misbehavior, employees who wish to misbehave will seek other ways to do it where controls are not so strong. This means you should use your risk assessment process to help prioritize where controls are most needed. If your company prohibits gifts and any travel other than for the submitting employee from being included in the expense report, you should consider requiring instead a check request form be used, which, Mixon noted, would be subject to stringent controls. He added that in such cases a checklist should be completed and attached to the check request which includes questions and disclosures designed to flush out exactly what was provided in the way of a business class airline, pocket money, event tickets, side trips, leisure activities, spouses or other relatives who might be traveling and why the travel had business purpose. Such an internal control would allow for a more streamlined processing of expense reports and still elevates the gifts/travel items to the appropriate level of review and requires appropriate documentation.

I inquired as to why a Compliance Officer relies on the audit controls that are in place regarding gifts because in many companies, internal audits of expense reports are common. Mixon noted that it is important to keep in mind that, with respect to gifts, internal audits most often constitute, at best, a detect control, which only gives comfort for some historical period and is not necessarily representative of the controls in place to prevent future violations. So, it will be a false sense of security if a Compliance Officer relies on the internal audit of expense reports to be the control needed over violation of Gift policies.

I thought about one line in Brooks’ piece, which seemed to echo Mixon’s thoughts on internal controls, where Brooks wrote, “Building and maintaining order…requires toughness of mind and rigid discipline to properly serve your own work.” By having the rigor to institute and enforce the types of internal controls Mixon has identified, you can go a long way towards detecting and more importantly preventing a FCPA violation from occurring.

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

September 29, 2014

TNG Premiers and Internal Controls for Gifts in a Best Practices Compliance Program

Star Trek TNGThis week, 27 years ago, Star Trek – The Next Generation (TNG) made its television debut. Rarely has there a follow up to a beloved original series (Star Trek – The Original Series (TOS)) that is equally treasured by fans. They say that your favorite Star Trek is the one you grew up with, so for me that is TOS and that will always be my most beloved Star Trek series, but for the younger generations TNG fills that bill. The series occurred some 70 years in the time after TOS so things were a bit different. One of the differences was on following the Prime Directive more rigorously. While Captain Kirk, who actually had a hand in drafting the Prime Directive, seemed to view it with situational ethics, Captain Picard was much more concerned about not violating it.

I thought about this evolution of the Prime Directive from TOS to TNG when considering what types of internal controls a compliance practitioner might consider in the area of gifts in a Foreign Corrupt Practices Act (FCPA) best practices compliance program. I have been continuing my exploration of internal controls with well-known expert Henry Mixon, Principal of Mixon-Consulting. Mixon believes that it would be reasonable to expect that internal controls over gifts would be designed to ensure that all gifts satisfy the criteria as defined and interpreted in Company policies. Generally speaking, these are fairly narrow, including a definition of the dollar limit, which must not be exceeded in order for gifts to be permissible, coupled with some subjective criteria such as the legality of the gifts for the recipient and whether the practice is customary within the country where the gift is delivered. The question I focus on is how to enforce the policies so that employees are not free to disregard them at will?

The Department of Justice (DOJ), in several enforcement actions and the FCPA Guidance has emphasized the importance of risk assessment and effective controls and building a program tailored to those risks. Many companies effectively minimize the risk of inappropriate gifts through stringent pre-approval requirements because a sufficiently robust and enforced pre-approval policy can reduce the number of gifts simply because of the headache of getting the pre-approval. This has the added benefit of ensuring enforcement of internal controls, largely because of the reduced volume of gifts being included in expense reports. Mixon cautions that in considering the effectiveness of controls, you must always keep in mind the most frequently used method for defeating an internal control, which is driven by a dollar amount criteria, is splitting the item into multiple parts in order to appear to stay under the limit and to avoid the defined approval authority based on the amount of the gift.

Mixon believes that the key analysis is whether there are controls in place to enforce the policies and whether those controls are documented. To help to answer this query, he posited that there are four issues to evaluate.

  • Is the correct level of person approving the payment / reimbursement for the gift?
  • Are there specific controls, including signoffs, to demonstrate that the gift had a proper business purpose?
  • Are the controls regarding gifts sufficiently preventative, rather than relying on detect controls?
  • If controls are not followed, is that failure detected by other internal controls or the compliance protocols?

While many compliance practitioners believe that employee expense reports are a sufficient internal control regarding gifts, because there are other ways in which a gift can be presented, there need to be other controls. Mixon believes that once your company policy on gifts has been finalized, the internal controls over expense reports fall into three basic areas: (1) The expense report format, including what information it requires; (2) Controls over the submitting employee and the preparation of the expense report; and (3) Controls to ensure the approvers do their review process properly.

Mixon believes the format itself of an expense report can go a long way toward prevention of violations of company policy. First it is important to have preprinted representations and certifications within the form because these can lead to “stop and think” type of controls, meaning the person submitting the expense report has to at least consider the information being submitted. The form can be signed without reading the preprinted representations, but if the employee and reviewers have been trained on how to review the expense report, it can be difficult to say later that the submitting employee did not understand what they were signing.

Mixon suggested two forms of representation, the Preparer’s representations and the Approver’s representations. The Preparer’s representations include ensuring that all items representing a proper business purpose comply with the company’s code of conduct, comply with local law and custom, and comply with all applicable company policies regarding FCPA compliance. The Approver’s representations ensure that all supporting documentation has been examined and that all documentation complies with applicable company policies, including the submission of original receipts. Further, the approver should certify that they have complied with all company policies regarding the review and approval of the expense report.

Mixon noted that some companies have two basic forms of expense reports. One is for situations in which all items pertain to US locations and do not involve any expenses incurred outside the US or for benefit of persons outside the US. The second is for items involving locations or persons outside the US. The international reporting form might have more stringent requirements and should provide for more detailed disclosures. It could require reporting, in a separate section of the expense report, all items that involve government officials, so that these items are not “buried” elsewhere in the expense report. Just as an added measure, the expense report includes a column where other expenses are reported which requires the submitter to check “Government Official YN?” this type of format should require sufficient disclosure of information regarding each item involving government officials. The next step in such an enhanced protocol would require a senior officer from the business unit to approve any reimbursements that meet certain criteria, for example, certain geographical areas or countries. Finally, such an enhanced representation could also include separate sections for each item requiring a description of the business purpose of meals, entertainment, names and business affiliation of all attendees, description of gifts and their business purpose, etc. A typical expense report requires this information to be on the receipt. Mixon believes that moving beyond simply requiring receipts and requiring such detail to be incorporated directly onto the expense reimbursement forms highlights the presence or absence of proper documentation much more readily. Mixon ended by noting it was incumbent to ensure reviewers sign off that each such item has documentation that required pre-approvals were obtained, if necessary.

While following the Prime Directive does not always lead to the result that the crew of TNG Enterprise desired; it did have the greater effect of allowing cultures and peoples to develop without interference. Internal controls around gifts can be used in a variety of ways in your best practices compliance program. They can certainly be used to detect an issue and perhaps even prevent an issue from becoming a full-blown FCPA violation, however, by using some of the techniques that Mixon has suggested you can move your compliance program to a proscriptive phase where you not only stop an issue from becoming a violation but through identification, you can move towards remediation as a part of your ongoing compliance efforts. Just as Star Trek’s Prime Directive had an ultimate purpose, if you can move your compliance program’s internal controls forward, you can help make them a part of your financial controls and thereby have a better run company.

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

September 26, 2014

West Side Story and GSK In China – Board Oversight and Tone in the Middle

West Side Story IIYesterday, I celebrated the anniversary of one of America’s cultural lows. But today, I am extremely pleased to open with exactly the opposite, that being one of America’s greatest gifts to the performing arts. For on this day in 1957, the musical West Side Story premiered on Broadway. There are so many facets to one of the great, even greatest, works of musical theater. Leonard Bernstein penned the score, Stephen Sondheim wrote the lyrics, Jerome Robbins choreographed the dance and the story was by Arthur Laurents, inspired by Romeo and Juliet.

There are many great songs, dances and moments in the play. Most of us (at least of my age) outside New York were introduced to the play via television where it ran for one showing in 1971. The show never toured until the 2000s. When I finally got to see the stage production I was absolutely blown away. I had never seen anything like and it and I will never forget the 5-counter point singing by Tony, Maria, Anita, Bernardo and the Sharks, and Riff and the Jets, as they all anticipate the events to come that night in the song Tonight’s Quintet. The show truly is one of America’s gems.

I thought about the continuing appeal of West Side Story as a musical and why the story continues to resonate with the American people when I continued to consider some of the lessons learned from the GlaxoSmithKline PLC (GSK) matter in China. Today’s areas for reflection should be the role of a company’s Board of Directors and the second is the ‘tone in the middle’. While we have not heard from the GSK Board on this case, it has become clear that the GSK Board was aware of both the anonymous whistleblower allegations and the release of the tape of the GSK China Country Manager and his girlfriend. One of the lessons learned from the GSK scandal is that a Board must absolutely take a more active oversight role not only when specific allegations of bribery and corruption are brought forward but also when companies are operating in high risk environments. Further how can a company move its message of doing business ethically and in compliance down the employee chain.

In a NACD Directorship article, entitled “Corruption in China and Elsewhere Demands Board Oversight”, authors Eric Zwisler and Dean Yoost noted that as “Boards are ultimately responsible for risk oversight” any Board of a company with operations in China “needs to have a clear understanding of its duties and responsibilities under the FCPA and other international laws, such as the U.K. Bribery Act”. Why should China be on the radar of Boards? The authors reported, “20 percent of FCPA enforcement actions in the past five years have involved business conduct in China. The reputational and economic ramifications of misinterpreting these duties and responsibilities can have a long-lasting impact on the economic and reputation of the company.”

The authors understand that corruption can be endemic in China. They wrote, “Local organizations in China are exceedingly adept at appearing compliant while hiding unacceptable business practices. The board should be aware that a well-crafted compliance program must be complemented with a thorough understanding of frontline business practices and constant auditing of actual practices, not just documentation.” Further, “the management cadence of monitoring and auditing should be visible to the board.” All of the foregoing would certainly apply to GSK and its China operations.

Moreover, the FCPA Guidance makes clear that resources and their allocation are an important part of any best practices compliance program. So if that risk is perceived to be high in a country such as China, the Board should follow the prescription in the Guidance, which states “the amount of resources devoted to compliance will depend on the company’s size, complexity, industry, geographical reach, and risks associated with the business. In assessing whether a company has reasonable internal controls, DOJ and SEC typically consider whether the company devoted adequate staffing and resources to the compliance program given the size, structure, and risk profile of the business.”

To help achieve these goals, the authors suggested a list of questions that they believe every director should ask about a company’s business in China.

  • How is “tone at the top” established and communicated?
  • How are business practice risks assessed?
  • Are effective standards, policies and procedures in place to address these risks?
  • What procedures are in place to identify and mitigate fraud, theft, and corruption?
  • What local training is conducted on business practices and is it effective?
  • Are incentives provided to promote the correct behaviors?
  • How is the detection of improper behavior monitored and audited?
  • How is the effectiveness of the compliance program reviewed and initiated?
  • If a problem is identified, how is an independent and thorough investigation assured?

Third parties generally present the most risk under a Foreign Corrupt Practices Act (FCPA) compliance program and are believed (at least anecdotally) to comprise over 90 percent of reported FCPA cases, which subsequently involve the use of third-party intermediaries such as agents or consultants. But this is broader than simply third party agents because any business opportunity in China will require some type of business relationship.

One of the major failings of the GSK Board was that it apparently did not understand the actual business practices that the company was engaging in through its China business unit. While $500MM may not have been a material monetary figure for the Board to consider; the payment of such an amount to any third party or group of third parties, such as Chinese travel agencies, should have been raised to the Board. All of this leads me to believe that the GSK Board was not sufficiently engaged. While one might think a company which had received a $3bn fine and was under a Corporate Integrity Agreement (CIA) for its marketing sins might have sufficient Board attention; perhaps legal marketing had greater Board scrutiny than doing business in compliance with the FCPA or UK Bribery Act. The Board certainly did not seem to understand the potential financial and reputational impact of a bribery and corruption matter arising in China. Perhaps they do now but, for the rest of us, I think the clear lesson to be learned is that a Board must increase oversight of its China operations from the anti-corruption perspective.

GSK Chief Executive Officer (CEO) Sir Andrew Witty has certainly tried to say all of the right things during the GSK imbroglio on China. But did that message really get down into to the troops at GSK China? Moreover, did that message even get to middle management, such as the GSK leadership in China? Apparently not so, one of the lessons learned is moving the Olympian Pronouncements of Sir Andrew down to lower levels on his company. Just how important is “Tone at the Top”? Conversely, what does it say to middle management when upper management practices the age-old parental line of “Don’t do as I do; Do as I say”? In his article entitled, “Ethics and the Middle Manager: Creating “Tone in The Middle” Kirk O. Hanson, listed eight specific actions that top executives could engage in which demonstrate a company’s and their personnel’s commitment to ethics and compliance. The actions he listed were:

  1. Top executives must themselves exhibit all the “tone at the top” behaviors, including acting ethically, talking frequently about the organization’s values and ethics, and supporting the organization’s and individual employee’s adherence to the values.
  2. Top executives must explicitly ask middle managers what dilemmas arise in implementing the ethical commitments of the organization in the work of that group.
  3. Top executives must give general guidance about how values apply to those specific dilemmas.
  4. Top executives must explicitly delegate resolution of those dilemmas to the middle managers.
  5. Top executives must make it clear to middle managers that their ethical performance is being watched as closely as their financial performance.
  6. Top executives must make ethical competence and commitment of middle managers a part of their performance evaluation.
  7. The organization must provide opportunities for middle managers to work with peers on resolving the hard cases.
  8. Top executives must be available to the middle managers to discuss/coach/resolve the hardest cases.

What about at the bottom, as in remember those China unit employees who claimed they were owed bonuses because their bosses had instructed them to pay bribes? Well if your management instructs you to pay bribes that is a very different problem. But if your company’s issue is how to move the message of compliance down to the bottom, Dawn Lomer, Managing Editor at i-Sight Software, provided some concrete suggestions in an article in the SCCE magazine, entitled “An ethical corporate culture goes beyond the code”, where she wrote that that the unofficial message which a company sends to its employees “is just as powerful – if not more powerful – than any messages carried in the code of conduct.” Lomer suggested that a company use “unofficial channels” by which your company can convey and communicate its message regarding doing business in an ethical manner and “influence employee behavior across the board.” Her suggestions were:

  1. Reward for Integrity - Lomer writes that the key is to reward employees for doing business in an ethical manner and that such an action “sends a powerful message without saying a word.”
  2. The three-second ethics rule – It is important that senior management not only consistently drives home the message of doing business ethically but they should communicate that message in a short, clear values statement.
  3. Environmental cues – Simply the idea that a company is providing oversight on doing business ethically can be enough to modify employee behavior.
  4. Control the images – It is not all about winning but conducting business, as it should be done.
  5. Align Messages – you should think about the totality of the messages that your company is sending out to its employees regarding doing business and make sure that all these messages are aligned in a way that makes clear your ethical corporate culture clear. 

The GSK case will be in the public eye for many months to come. Both the UK Serious Fraud Office (SFO) and US authorities have open investigations into the company. Just as the five counter-point singing or the rooftop symphonic dance scene to the song America demonstrates the best of that art form; you can draw lessons from GSK’s miss-steps in China now for implementing or enhancing your anti-corruption compliance program going forward now.

And while you are ending your week of considering GSK and its lessons learned for your compliance program, crank up your speakers to 11 and listen to some five counter-point singing the movie version of the Tonight Quintet, by clicking 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

September 25, 2014

Come On Get Happy – The Partridge Family and GSK’s Internal Investigation

Partridge Family BusToday we celebrate an anniversary of one of the all-time lows in the American cultural milieu; for on this date in 1970, the television show The Partridge Family appeared on the ABC Television network. Symbiotically created from the ashes of the television show The Monkees and the real-life family pop group The Cowsills; The Partridge Family starred, as its TV-mom, Oscar winning actress Shirley Jones and as her eldest TV son, and teenaged girl heartthrob, her real-life stepson David Cassidy. Proving once again that 1960s and 1970s television really was largely a cultural wasteland, the family romped and sang their way across a never-ending sunny southern California in multi-colored converted school bus. While the episodes themselves were as close to putrid as one can get, they did have better success with their lip-synced music from each episode. One song, I Think I Love You, reached No. 1 on the Billboard Pop Charts that year.

I thought about this strange convergence of history and culture (or perhaps the lack of culture) when considering more lessons learned from the GlaxoSmithKline PLC (GSK) corruption scandal. I was particularly focused on GSK’s response to at least two separate reports from an anonymous whistleblower (brilliantly self-monikered as GSK Whistleblower) of allegations of bribery and corruption going on in the company’s China business unit. One of the clear lessons from the GSK matter is that serious allegations of bribery and corruption require a serious corporate response. Not, as GSK appears to have done, in their best Inspector Clouseau imitation, not being able to find the nose on their face.

Further, and more nefariously, was GSK’s documented treatment of and history with internal whistleblowers. One can certainly remember GSK whistleblower Cheryl Eckard. A 2010 article in The Guardian by Graeme Wearden, entitled “GlaxoSmithKline whistleblower awarded $96m payout”, where he reported that Eckard was fired by the company “after repeatedly complaining to GSK’s management that some drugs made at Cidra were being produced in a non-sterile environment, that the factory’s water system was contaminated with micro-organisms, and that other medicines were being made in the wrong doses.” She later was awarded $96MM as her share of the settlement of a Federal Claims Act whistleblower lawsuit. Eckard was quoted as saying, “It’s difficult to survive this financially, emotionally, you lose all your friends, because all your friends are people you have at work. You really do have to understand that it’s a very difficult process but very well worth it.” So to think that GSK may simply have been SHOCKED, SHOCKED, that allegations of corruption were brought by an internal whistleblower may well be within the realm of accurate.

There would have seemed to have been plenty of evidence to let the company know that something askance was going on in its Chinese operations. The international press was certainly able to make that connection early on in the scandal. An article in the Financial Times (FT), entitled “China accuses GSK of bribery” by Kathrin Hille and John Aglionby, reported “GSK said it had conducted an internal four-month investigation after a tip-off that staff had bribed doctors to issue prescriptions for its drugs. The internal inquiry found no evidence of wrongdoing, it said.” Indeed after the release of information from the Chinese government, GSK said it was the first it had heard of the investigation. In a prepared statement, quoted in the FT, GSK said ““We continuously monitor our businesses to ensure they meet our strict compliance procedures – we have done this in China and found no evidence of bribery or corruption of doctors or government officials.” However, if evidence of such activity is provided we will act swiftly on it.”

Laurie Burkitt, reporting in the Wall Street Journal (WSJ) in an article entitled “China Accuses Glaxo of Bribes”, wrote that “Emails and documents reviewed by the Journal discuss a marketing strategy for Botox that targeted 48 doctors and planned to reward them with either a percentage of the cash value of the prescription or educational credits, based on the number of prescriptions the doctors made. The strategy was called “Vasily,” borrowing its name from Vasily Zaytsev, a noted Russian sniper during World War II, according to a 2013 PowerPoint presentation reviewed by the Journal.” Burkitt reported in her article that “A Glaxo spokesman has said the company probed the Vasily program and “[the] investigation has found that while the proposal didn’t contain anything untoward, the program was never implemented.”” From my experience, if you have a bribery scheme that has its own code name, even if you never implemented that scheme, it probably means that the propensity for such is pervasive throughout the system.

I have often written about the need for a company to have an investigative protocol in place so that it is not making up its process in the face of a crisis. However the GSK matter does not appear to be that situation. It would not have mattered what investigation protocol that GSK followed, it would seem they were determined not to find any evidence of bribery and corruption in their China business unit. So the situation is more likely that GSK should have brought in a competent investigation expert law firm to head up their investigation in the face of this anonymous whistleblower’s allegations.

In an ACC Docket article, entitled “Risks and Rewards of an Independent Investigation”, authors James McGrath and David Hildebrandt discuss the use of specialized outside counsel to lead an independent internal investigation as compliance and ethics best practices. This is based upon the US Sentencing Guidelines, under which a scoring system is utilized to determine what a final sentence should be for a criminal act. Factors taken into account include the type of offense involved and the severity of the said offense, as well as the harm produced. Additional points are either added or subtracted for mitigating factors. One of the mitigating factors can be whether an organization had an effective compliance and ethics program. McGrath and Hildebrandt argue that a company must have a robust internal investigation.

McGrath and Hildebrandt take this analysis a step further in urging that a company, when faced with an issue such as an alleged Foreign Corrupt Practices Act (FCPA) violation, should engage specialized counsel to perform the investigation. There were three reasons for this suggestion. The first is that the Department of Justice (DOJ) would look towards the independence and impartiality of such investigations as one of its factors in favor of declining or deferring enforcement. If in-house counsel were heading up the investigation, the DOJ might well deem the investigative results “less than trustworthy”.

Matthew Goldstein and Barry Meier discussed the need for independence from the company being investigated in an article the New York Times (NYT) about the General Motors (GM) internal investigation entitled “G.M Calls the Lawyers”. They quoted William McLucas, a partner at WilmerHale, who said, “If you are a firm that is generating substantial fees from a prospective corporate client, you may be able to come in and do a bang-up inquiry. But the perception is always going to be there; maybe you pulled your punches because there is a business relationship.” This is because if “companies want credibility with prosecutors and investors, it is generally not wise to use their regular law firms for internal inquiries.” Another expert, Charles Elson, a professor of finance at the University of Delaware who specializes in corporate governance, agreed adding, “I would not have done it because of the optics. Public perception can be affected by using regular outside counsel.””

Adam G. Safwat, a former deputy chief of the fraud section in the Justice Department, said that the key is “Prosecutors expect an internal investigation to be an honest assessment of a company’s misdeeds or faults, “What you want to avoid is doing something that will make the prosecutor question the quality of integrity of the internal investigation.”” Also quoted was Internal Investigations Blog editor, Jim McGrath who said, “A shrewd law firm that gets out in front of scandal can use that to its advantage in negotiating with authorities to lower penalties and sanctions. There is a great incentive to ferret out information so they can spin it.”

The GSK experience in China will inform compliance practitioners for years to come with the company’s plethora of miss-steps. Perhaps one day the company will become as successful as The Partridge Family and they can open their annual meeting with The Partridge Family Theme - Come On Get Happy!

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

September 24, 2014

Lessons from GSK in China – Internal Controls, Auditing and Monitoring

InvestigationsOne of the great things about writing your own blog is that sometimes you can get going on a subject and just explore it. While I think I might sometimes get carried away when I delve into a topic, I certainly learn much while doing so. This week appears to be such a situation where in studying and researching the GlaxoSmithKline PLC (GSK); I find that the case has much more to inform the compliance practitioner. So I am going to try and tie together some of the major lessons learned from the GSK Chinese enforcement action for the remainder of the week and present to you how such lessons might assist you in designing, implementing or upgrading a best practices compliance program. Today I want to look at internal controls, auditing and monitoring.

One of the questions that GSK will have to face during the next few years of bribery and corruption investigations is how an allegedly massive bribery and corruption scheme occurred in its Chinese operations? The numbers went upwards of $500MM, which coincidentally was the amount of the fine levied by the Chinese court on GSK. It is not as if the Chinese medical market is not well known for its propensity towards corruption, as prosecutions of the Foreign Corrupt Practices Act (FCPA) are littered with the names of US companies which came to corruption grief in China. GSK itself seemed to be aware of the corruption risks in China. In a Reuters article, entitled “How GlaxoSmithKline missed red flags in China”, Ben Hirschler reported that the company had “more compliance officers in China than in any country bar the United States”. Further, the company conducted “up to 20 internal audits in China a year, including an extensive 4-month probe earlier in 2013.” GSK even had PricewaterhouseCoopers (PwC) as its outside auditor in China. Nevertheless, he noted, “GSK bosses were blindsided by police allegations of massive corruption involving travel agencies used to funnel bribes to doctors and officials.”

Internal Controls

Where were the appropriate internal controls? You might think that a company as large as GSK and one that had gone through the ringer of a prior Department of Justice (DOJ) investigation resulting in charges for off-label marketing and an attendant Corporate Integrity Agreement (CIA) might have such controls in place. It was not as if the types of bribery schemes in China were not well known. In an article in the Financial Times (FT), entitled “Bribery built into the fabric of Chinese healthcare system”, reporters Jamil Anderlini and Tom Mitchell wrote about the ‘nuts and bolts’ of how bribery occurs in the health care industry in China. The authors quoted Shaun Rein, a Shanghai-based consultant and author of “The End of Cheap China”, for the following “This is a systemic problem and foreign pharmaceutical companies are in a conundrum. If they want to grow in China they have to give bribes. It’s not a choice because officials in health ministry, hospital administrators and doctors demand it.”

Their article discussed the two primary methods of paying bribes in China: the direct incentives and indirect incentives method. Anderlini and Mitchell reported, “The 2012 annual reports of half a dozen listed Chinese pharmaceutical companies reveal the companies paid out enormous sums in “sales expenses”, including travel costs and fees for sales meetings, marketing “business development” and “other expenses”. Most of the largest expenses were “travel costs or meeting fees and the expenses of the companies’ sales teams were, in every case, several multiples of the net profits each company earned last year.””

It would be reasonable to expect that internal controls over gifts would be designed to ensure that all gifts satisfy the required criteria, as defined and interpreted in Company policies. It should fall to a Compliance Officer to finalize and approve a definition of permissible and non-permissible gifts, travel and entertainment and internal controls will follow from such definition or criteria set by the company. These criteria would include the amount of the spend, localized down into increased risk such the higher risk recognized in China. Within this context, noted internal controls expert Henry Mixon has suggested the following specific controls. (1) Is the correct level of person approving the payment / reimbursement? (2) Are there specific controls (and signoffs) that the gift had proper business purpose? (3) Are the controls regarding gifts sufficiently preventative, rather than relying on detect controls? (4) If controls are not followed, is that failure detected?

Auditing Lessons Learned

Following Mixon’s point 4 above, what can or should be a company’s response if one country’s gifts, travel and entertainment expenses were kept ‘off the books’? This is where internal audit or outside auditors are critical. Hirschler quoted an un-named source for the following, ““You’d look at invoices and expenses, and it would all look legitimate,” said a senior executive at one top accountancy firm. The problem with fraud – if it is good fraud – is it is well hidden, and when there is collusion high up then it is very difficult to detect.”” Jeremy Gordon, director of China Business Services was quoted as saying “There is a disconnect between the global decision makers and the guys running things on the ground. It’s about initially identifying red flags and then searching for specifics.”

There are legitimate reasons to hold medical conferences, such as to make physicians aware of products and the latest advances in medicine, however, this legitimate purpose can easily be corrupted. Hirschler quoted Paul Gillis, author of the China Accounting Blog, for the following “Travel agencies are used like ATMs in China to distribute out illegal payments. Any company that does not have their internal audit department all over travel agency spending is negligent.” Based on this, GSK’s auditors should have looked more closely on marketing expenses and more particularly, the monies spent on travel agencies. Hirschler wrote, “They [un-named auditing experts] say that one red flag was the number of checks being written to travel agencies for sending doctors to medical conferences, although this may have been blurred by the fact that CME accounts for a huge part of drug industry marketing.”

Another issue for auditing is materiality. If GSK’s internal auditors had not been trained that there is no materiality standard under the FCPA, they may have simply skipped past a large number of payments made that were under a company’s governance procedure for elevated review of expenses. Further, if more than one auditor was involved with more than one travel agency, they may not have been able to connect the dots regarding the totality of payments made to one travel agency.

Ongoing Monitoring

A final lesson learned for today is monitoring. As Stephen Martin often says, many compliance practitioners confuse auditing with monitoring. Monitoring is a commitment to reviewing and detecting compliance programs in real time and then reacting quickly to remediate them. A primary goal of monitoring is to identify and address gaps in your program on a regular and consistent basis. Auditing is a more limited review that targets a specific business component, region, or market sector during a particular timeframe in order to uncover and/or evaluate certain risks.

Here I want to focus on two types of ongoing monitoring. The first is relationship monitoring, performed by companies such Boston-based Catelas, through software products. It was reported in a Wall Street Journal (WSJ) article, entitled “Glaxo Probes Tactics Used to Market Botox in China”, that internal GSK emails showed the company’s China sales staff were instructed by local managers to use their personal email addresses to discuss marketing strategies related to Botox. The Catelas software imports and analyzes communications data, like email, IM, telephony and SMTP log files from systems such as Microsoft Exchange Servers and Lotus Notes. The software then leverages social network analysis and behavioral science algorithms to analyze this communications data. These interactions are used to uncover and display the networks that exist within companies and between the employees of companies. Additionally, relationships between employees and external parties such as private webmail users, competitors and other parties can be uncovered.

The second type of monitoring is transaction monitoring. Generally speaking, transaction monitoring involves review of large amounts of data. The analysis can be compared against an established norm which is derived either against a businesses’ own standard or an accepted industry standard. If a payment, distribution or other financial payment made is outside an established norm, thus creating a red flag that can be tagged for further investigation.

GSK’s failure in these three areas now seems self-evident. However, the company’s foibles can be useful for the compliance practitioner in assessing where their company might be in these same areas. Moreover, as within any anti-corruption enforcement action, you can bet your bottom dollar that the regulators will be assessing best practices going forward based upon some or all of GSK’s miss-steps going forward.

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

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