FCPA Compliance and Ethics Blog

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

1 Comment »

  1. Tom: What if any should corporations do with the use of outside Counsel as it pertains to Internal controls? I’ve been reading quite a bit lately (hearing) that corporations should hire outside counsel as another layer of protection, privilege, etc…and I’m wandering if you thought it wise to hire outside counsel to give advice as towards substance?

    Comment by Mike Brown — October 14, 2014 @ 1:21 pm | Reply

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