FCPA Compliance and Ethics Blog

November 7, 2012

DEEP LEVEL DUE DILIGENCE: What you need to know

Ed. Note-today we are pleased to have a guest post from our colleague Candice Tal.

Would you do business with an entity that has been in business less than 2 years, has no internet presence and uses a military-style compound that for it’s headquarters where no employees arrive to work each day?  This may well be the next reseller or distributor your company works with in Africa, or some parts of Russia or China. How about the entrepreneurial young executive that is starting a new business which has no physical office yet—is that a risk factor?  Is he still working for his old employer with whom you have a contractual relationship?  Is there any possibility, or even perception, of kickbacks there?  The old adage: “what you don’t know can’t hurt you” is certainly a reckless approach given today’s global anti-corruption initiatives.

Minimizing corporate liability exposure and effective regulatory compliance are key to your business’ global success.  Business expansion through global growth, investments, M&A transactions, joint ventures, private equity deals, and other financial transactions are all higher risk endeavors, especially in emerging markets where bribes are commonplace, business relationships are often opaque and information may be extremely hard to pin down.

So what do you need to know about your prospective business partners & how do you find out these kinds of details when you are sitting in an office 5,000 miles away?

Progressive levels of due diligence form a great approach to cost-effectively and rapidly demonstrating compliance with international regulations designed to detect and prevent bribery of foreign officials.  With FCPA fines and penalties averaging $18million, multi-level due diligence is a “no-brainer”.  In fact most large corporations today (nearly 80%) perform fast, basic due diligence reviews of suppliers, resellers, distributors and third party agents for AML, KYC, FCPA, & UKBA compliance.

Although important as a first step in preventing bribery, basic due diligence is only a limited tool in detecting and preventing a host of other corrupt and criminal activities.  Deeper levels of due diligence are essential steps in yielding valuable information to make critical business and financial decisions, and at the same time accomplish regulatory compliance.

First level due diligence typically consists of checking individual names and company names through several hundred Global Watch lists comprised of anti-money laundering, anti-bribery, sanctions lists & other financial corruption & criminal databases.  These global lists create a useful first-level screening tool to detect potential red flags for corrupt activities.  It is also a very inexpensive first step in compliance from an investigative viewpoint.  This basic level is extremely important for companies to complement their compliance policies and procedures; demonstrating a broad intent to actively comply with international regulatory requirements.

What are next levels of due diligence?  Supplementing these Global Watch lists with a deeper screening of international media (typically the major newspapers & periodicals from all countries) plus detailed internet searches, will often reveal other forms of corruption-related information and may expose  undisclosed or hidden information about the company, it’s key executives and associated parties.

This combined information creates a more effective screening for corruption compliance purposes.  Red/ yellow/green flag alerts based on these results can then be used to prioritize in-depth investigations. Summary reports should show the information sources reviewed and recommendations for further actions if indicated.  Green flags suggest no further actions based on findings; however the information sources  searched are limited and should not be considered the same as deep-level due diligence.  Red flags indicate the possibility is high that corruption, bribery, money laundering and or undue political influence may be likely, or is actively occurring.  Designing a multi-layered investigative approach from this point is essential in order to implement an effective business risk mitigation and compliance strategy.

These first two levels of due diligence alone are not sufficient if you have a substantial operation at stake, or a multi-million dollar investment, developing a new product, building a larger facility, developing a new market sector or creating a new supply chain for your existing products or services.  After all, why take risks when you don’t have to.

Next level due diligence should also include an in-depth background check of key executives or principal players.  These are not routine employment-type background checks which are simply designed to confirm existing information; but rather executive due diligence checks designed to investigate hidden, secret or undisclosed information about that individual.

Reputational information, involvement in other businesses, direct or indirect involvement in other law suits, history of litigious and other lifestyle behaviors which can adversely affect your business, and public perceptions of impropriety, should they be disclosed publically.

One litmus test would be: How would it look to the public and your shareholders if an executive immerses your company in questionable business practices or regulatory violations?

About 20% of executives do not check out well.  As the saying goes: “people are people”, and executives reflect most of the same issues seen in other employee groups.  Most frequently the adverse issues for executives involve undisclosed business dealings that may compromise your company’s new venture, SEC violations, criminal history, no degree(s) earned, loss of professional licensure, mis-statement of personal success/wealth, fraudulent activity and multiple bankruptcies.  In many parts of the world bribery and corruption are considered a normal part of business dealings.

Deep-level due diligence investigations are designed to supply you with comprehensive analysis of all available public records data supplemented with detailed field intelligence to identify known and more importantly unknown conditions.  Seasoned investigators who know the local language and are familiar with local politics bring an extra layer of depth assessment to an in country investigation.

Direction of the work and analyzing the resulting data is often critical to a successful outcome; and key to understanding the results both from a technical perspective and understanding what the results mean in plain English.  Investigative reports should include actionable recommendations based on clearly defined assumptions or preferably well-developed factual data points.

What are the benefits of Deep Level Due Diligence?  In addition to regulatory compliance and protecting your Board Of Directors, if a deal or business relationship is too risky the company has an informed option to re-negotiate or fundamentally change the terms of the deal, initiate damage control if needed, or even pull out of the deal entirely.

Comprehensive investigative reports will provide effective, meaningful results & actionable reports which are directly tied to corporate objectives.

Deep level due diligence should have a targeted approach articulated in a scope of work; these are not random investigations.  The more that is known about your corporate objectives from the start of the investigation, the more likely the investigators are to provide useful information.  All of this can be accomplished through NDA’s or other contract products.

Older style due diligence investigations used to include all available information, including vehicle descriptions, license plates & telephone numbers of all parties associated with the identified executives & businesses.  These old-school investigations were based on traditional law enforcement fact-gathering and evidence based reporting. However unless you plan to conduct an undercover investigation or sting operation, these data points are rarely of significance for due diligence purposes.

What is of concern in deep level due diligence:

  • Physical description / confirmation of the premises
  • Photographic evidence of facility
  • Evidence of employees showing up to work (not a “shop-front” façade)
  • Business operational & trade reputation
  • Other significant business intelligence
  • Undisclosed business information
  • Transaction evaluation
  • Competitive intelligence
  • Well-developed internet presence
  • Regional business scalability Issues
  • Issues preventing scalability (politics, lack of infrastructure to deliver goods, etc)
  • History of business criminal & civil lawsuits
  • Executive background check due diligence
  • Undisclosed personal information of key managers
  • Involvement in other business entities
  • Identity of key individuals
  • Financial assets
  • Bankruptcy history
  • Sources of wealth
  • Tax evasion
  • Confirming prior business sales (successes/failures)
  • Misrepresentations in company/exec background
  • Significant managerial issues
  • Criminal history
  • Civil litigation history
  • Records of other disputes
  • Environmental liabilities
  • SEC violations
  • Sanctions
  • Sales history
  • Client /supplier relationships
  • Procurement fraud
  • Political influence issues & public official relationships
  • Public relations issues
  • Executive & BOD lifestyle issues
  • Ties to organized crime
  • Known family connections to various groups (org crime, politicians, activist groups)

These are some of the issues that may impact the progression of a deal, result in adverse PR, or yield ethics violations or regulatory non-compliance issues.  In-country due diligence, using local investigators can reveal far more than public records information obtained in the more basic Tier 1 & 2 type investigations.  Careful analysis of the information obtained is key to successful investigative due diligence.

Controlling identified risk factors will often yield greater mid-range and long-term profitability with a relatively small capital outlay.  Due diligence investigations often form a key portion of large corporations’ emerging market & high growth markets success strategy in addition to meeting regulatory compliance objectives.

Deep level due diligence reports should provide corporate clients the assurance needed to comply with global anti-corruption regulations FCPA/UKBA and to engage in new markets with clearly identified and manageable risks.

For more information, contact: Candice Tal, CEO, Infortal Worldwide.

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.

Armistice Day: The Risks and Rewards of Foreign Joint Ventures

Ed. Note-we continue our series of guest posts from our colleague Mary Shaddock Jones, who today looks at Joint Ventures and has some pointers for avoiding pitfalls under the FCPA.

In December 2010, RAE Systems Inc., a publicly-traded U.S. corporation headquartered in San Jose, Calif., has entered into an agreement with the Department of Justice to pay a $1.7 million penalty for violations of the Foreign Corrupt Practices Act. According to information contained in the non-prosecution agreement (NPA), RAE Systems developed and manufactured rapidly deployable, multi-sensor chemical and radiation detection monitors and networks.   From 2005 to 2008, the company had significant operations in the People’s Republic of China (PRC), and sold its products and services primarily through two subsidiaries organized as joint ventures with local Chinese entities: RAE-KLH (Beijing) Co. Limited (RAE-KLH) and RAE Coal Mine Safety Instruments (Fushun) Co. Ltd. (RAE Fushun).

As to RAE-Fushun, the NPA states that “RAE Systems did not conduct pre-acquisition corruption due diligence of RAE Fushun” but that “given RAE’s System’s experience with KLH described above, the high-risk nature of the location, and the existence of numerous government customers, pre-acquisition corruption-focused due diligence was merited. The NPA further states “as was later confirmed, improper business practices had occurred at RAE Fushun before the acquisition and continued post-acquisition, as RAE Systems failed to implement an effective system of internal controls at RAE Fushun.”

The practical pointer for today’s blog is this – FCPA issues can arise in joint venture transactions.  In certain circumstances, it may be necessary to have a “local partner” in order to access local labor, equipment, financing or other resources.  In other instances, you may not be able to work in a particular location without contracting with an arm of the local government.  What types of joint ventures is your company engaged in?  Joint Ventures can take a wide array of forms, from the simple contractual agreement relating to a single project wherein each partner undertakes to perform certain activities and receive certain benefits and compensation in return, to the formation of a new legal entity with joint management shared between the partners.  A joint venture can be modified even further by differentiating partners as either active or passive. Although there is a wide variance in how joint ventures can be structured, the key to remember is that by entering into a joint venture each partner becomes potentially exposed to the FCPA liabilities created by the acts of the other partner.

Joint Venture arrangements are particularly common in the oil and gas industry.  In January of this year, Marubeni Corporation agreed to pay a $54.6 million criminal penalty to resolve FCPA related charges for its participation in a decade-long scheme to bribe Nigerian government officials to obtain engineering, procurement and construction contracts. According to court documents, Marubeni was hired as an agent by the four-company joint venture TSKJ, to help TSKJ obtain and retain EPC contracts to build liquefied natural gas (LNG) facilities on Bonny Island, Nigeria, by offering to pay and paying bribes to Nigerian government officials, among other means. TSKJ was comprised of Technip S.A., Snamprogetti Netherlands B.V., Kellogg Brown & Root Inc. and JGC Corporation.  Between 1995 and 2004, TSKJ was awarded four EPC contracts, valued at more than $6 billion, by Nigeria LNG Ltd. (NLNG) to build the LNG facilities on Bonny Island.  The government-owned Nigerian National Petroleum Corporation (NNPC) was the largest shareholder of NLNG, owning 49 percent of the company. Ultimately, the total fines and penalties arising out of the TSKJ joint venture amounted to $1.7 Billion Dollars.

Generally in Nigeria, all petroleum production and exploration is taken under the auspices of joint ventures between foreign multi-national corporations and the Nigerian National Petroleum Company (Government Owned entity).  Examples include: Chevron Nigeria Limited (CNL): A joint venture between NNPC (60%) and Chevron (40%); Total Petroleum Nigeria Limited (TPNL): A joint venture between NNPC (60%) and Total; and, Mobil Producing Nigeria Unlimited (MPNU): A joint venture between the NNPC (60%) and Exxon-Mobil (40%).

In all of the examples provided above, the Nigerian National Oil Company held the majority ownership in the joint venture, but this fact alone does not release the minority owners from the risk of FCPA liability.  The Anti-Bribery provisions of the FCPA prohibit improper payments on behalf of the joint  venture entity even if the U.S. partner is not the majority holder of the venture.  Under the FCPA’s accounting provisions, which only apply to issuers, an issuer that owns a minority interest in a joint venture may also be liable under accounting provisions. The issuer may, however, avoid liability by demonstrating that it undertook “good faith efforts” to “use its influence, to the extent reasonable under the issuer’s circumstances,” to cause the joint venture to implement controls designed to ensure compliance with the accounting provisions.  15 U.S.C. § 78(m)(b)(6).

Joint Venture Agreements involving National Oil Companies are complex and must be carefully written. Special attention should be paid to the inclusion of compliance clauses into the Joint Venture Agreement.  Here are just a few items to consider including:

  1.  Specific clauses prohibiting all forms of bribery and corruption including hospitality/gifts/entertainment/travel/facilitating payments.
  2. Clauses requiring proper recordkeeping to comply with the FCPA books and records provision, as well as provisions addressing the implementation of internal accounting controls.
  3. Representations and warranties regarding compliance with the anti-bribery and corruption clauses;
  4. Right to Audit books and records for compliance with the anti-bribery and corruption clauses
  5. Rights of withdrawal from the JV in the event of unethical or illegal conduct by the other partner (or its agents)

On November 8, 2006, Wal-Mart expanded its operations internationally into Canada.  As most of you know, six years later, in 2012, Wal-Mart found itself embroiled in an FCPA investigation due to its expansion into Mexico.  Tomorrow, November 8th, we will examine some lessons learned from Wal-Mart’s investigation.  Stay Tuned.

 Mary Shaddock Jones has practiced law for 25 years in Texas and Louisiana primarily in the international marine and oil service industries.  She was of the first individuals in the United States to earn TRACE Anti-bribery Specialist Accreditation (TASA).  She can be reached at msjones@msjllc.com or 337-513-0335. Her associate, Miller M. Flynt, assisted in the preparation of this series.  He can be reached at mmflynt@msjllc.com.

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.

Blog at WordPress.com.