Right to Retire Or Termination: Remediation of Leadership To Foster Compliance

Many historians have long given 476 AD as the date of the fall of the Roman Empire. Further, it was from this date forward that Europe began its long slide into the abyss, which came to be known as the Dark Age. However, this view was challenged in 1971 by Peter Brown, with the publication of his seminal work “The World of Late Antiquity”. One of the precepts of Brown’s work was to reinterpret the 3rd to 8^th centuries not as simply a decline of the greatness that had been achieved in the heydays of the Roman Empire, but more on their own terms. It was in the year of 476 AD that the last Roman Emperor, Romulus Augustulus, left the capital of Rome in disgrace. However as Brown noted, he was not murdered or even thrown out but allowed to retire to his country estates, sent there by the conquers of the western half of the Roman Empire, the Goths. Not much conquering going on if a ruler is allowed to ‘retire’, it was certainly a replacement but not quite the picture of marauding barbarians at the gate.

I thought about this anomaly of retirement by a leader in the context where a company or other entity might be going through investigations for corruption and non-compliance with such laws as the Foreign Corrupt Practices Act (FCPA) or UK Bribery Act. Yesterday I wrote about three recent articles and what they showed about a company’s oversight of its foreign subsidiaries. Today I want to use these same articles to explore what a company’s response and even responsibility should be to remediate leadership under which the corruption occurs. The first was an article in the New York Times (NYT), entitled, “Another Scandal Hits Citigroup’s Moneymaking Mexican Division” by Michael Corkery and Jessica Silver-Greenberg. Their article spoke about the continuing travails of Citigroup’s Mexican subsidiary Banamex. Back in February, the company reported “a $400 million fraud involving the politically connected, but financially troubled, oil services firm Oceanografía.”

This has led Citigroup to ever so delicately try to oust the leader of its Mexico operations, Mr. Medina-Mora, by encouraging him to retire. While Citigroup did terminate 12 individuals around the Oceanografía scandal earlier in the year, it has not changed the employment status of the head of the Mexico business unit. This may be changing as the article said, “In a delicate dance, Citigroup is encouraging its Mexico chairman, Manuel Medina-Mora, 64, to retire, according to four people briefed on the matter. The bank has been quietly laying the groundwork for his departure, which could come by early next year, the people said. Still, Mr. Medina-Mora’s business acumen and connections to the country’s ruling elite have made him critical to the bank’s success in Mexico. Citigroup and its chairman, Michael E. O’Neill, cannot afford to alienate Mr. Medina-Mora and risk jeopardizing those relationships, these people said.”

Should Mr. Medina-Mora be allowed to retire? Should he even be required to retire? What about the ‘mints money’ aspect of the Mexican operations for Citigroup? Was any of that money minted through violations of the FCPA or other laws? What will the Department of Justice (DOJ) think of Citigroup’s response or perhaps even its attitude towards this very profitable business unit and Citigroup’s oversight, lax or other?

Does a company have to terminate employees who engage in corruption? Or can it allow senior executives to gracefully retire into the night with full pension and other golden parachute benefits intact? What if a company official “purposely manipulated appointment data, covered up problems, retaliated against whistle-blowers or who was involved in malfeasance that harmed veterans must be fired, rather than allowed to slip out the back door with a pension.” Or engaged in the following conduct, “had steered business toward her lover and to a favored contractor, then tried to “assassinate” the character of a colleague who attempted to stop the practice.” Finally, what if yet another company official directed company employees to “delete hundreds of appointments from records” during the pendency of an investigation?

All of the above quotes came from a second NYT article about a very different subject. In the piece, entitled “After Hospital Scandal, V.A. Official Jump Ship”, Dave Phillips reported that two of the four VA Administration executives who engaged in the above conduct and were selected for termination, had resigned before they could be formally terminated. The article reported that the VA “had no legal authority to stop” the employees from resigning. Current VA Secretary Robert McDonald was quoted in the article as saying, “It’s also very common in the private sector. When I was head of Procter & Gamble, it happened all the time, and it’s not a bad thing — it saves us time and rules out the possibility that these people could win an appeal and stick around.” Plus, he said, their records reflect that they were targeted for termination. “They can’t just go get a job at another agency,” Mr. McDonald said. “There will be nowhere to hide.”

The third article was in the Wall Street Journal (WSJ) and entitled, “GM Says Top Lawyer to Step Down”. In this piece, reporters John D. Stroll and Joseph B. White, with contributions from Chris Matthews and Joann Lublin, reported that General Motors (GM) General Counsel (GC) Michael Millikin will retire early next year. Milliken is famously the GC who claimed not to know what was going on in his own legal department around the group’s settlements of product liability claims of faulty ignition switches. Milliken claimed he was kept “in the dark” by his own lieutenants about the safety issues involved with this group of litigation. Does Milliken have any responsibility for the failures of GM around this safety issue? What does his apparent graceful retirement say about the corporate culture of GM and its desire to actually change anything in the light of its ongoing travails? Of course one might cynically point to GM’s failure to even have a Chief Ethics and Compliance Officer as evidence of the company’s attitude towards compliance and ethics. (I wonder how that might look to the DOJ/Securities and Exchange Commission (SEC) if GM goes under any FCPA scrutiny?)

With Citigroup, the Department of Veterans Affairs and GM, we have three separate excuses for companies (and a Cabinet level department) not disciplining top employees for ethical and/or compliance failures. At Citigroup, the excuse is apparently that it does not want to rock the boat from a top producing foreign subsidiary by terminating the head of the subsidiary under investigation. At the Department of Veterans Affairs, the excuse seems to be they can go ahead and resign because we prefer to get rid of them that way. At GM, it is not clear why the GC who claimed not to know what was going on in even his own law department can ride off into the sunset with nary a contrary word in sight. Millikin’s conduct would seem to be the product of a larger cultural issue at GM.

I thought about how the DOJ might look at these situations for companies if a FCPA claim were involved. Even with McDonald’s observations about what happened when he was with Procter & Gamble; does a company show something less than commitment to having a culture of compliance if it allows an employee to retire? What does it say about Citigroup and its culture given the current dance it is having with its head of the Mexico unit? What about GM and its Sgt. Schultz of a GC and his ‘I was in the dark posture’? As stated by Mike Volkov, in his post entitled “Goodbye Mr. Millikin: GM’s Continuing Culture Challenges”, GM does under appear to understand the situation it finds itself in currently over its failures. He wrote, “GM still does not understand the significance of its governance failure…GM should have taken dramatic and affirmative steps to create a new culture – resources and new initiatives should be launched to rid GM of its current culture and replace it with a new speak up culture. It is a daunting task in such a large company but it has to be done. Until GM wakes up, missteps and failures will continue.” One might say the same for Citigroup and the Department of Veterans Affairs as well.

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

Carlton Fisk, The Homer and Oversight of a Profitable Subsidiary

Today we celebrate one of the great moments in World Series history. At approximately at 12:34 AM on this date in 1975, Carlton Fisk came to bat at the bottom of the 12^th, in Game 6 of the World Series between the Boston Red Sox and Cincinnati Reds. He hit a pitch down the left field line. He stood at the plate, bouncing up and down and flailing at the ball as though he was helping an airplane land on a dark runway. “I was just wishing and hoping,” he said at a ceremony some years later. “Maybe, by doing it, you know, you ask something of somebody with a higher power. I like to think that if I didn’t wave, it would have gone foul.” Whether or not the waving was responsible, the ball bounced off of the bright-yellow foul pole above the Green Monster for a home run. Fenway’s organist played the Hallelujah Chorus from Handel’s Messiah while Fisk rounded the bases. One for the ages indeed as it appeared the Baseball Gods might finally be smiling on the Red Sox nation. Alas, they lost the next game and it was not to be for another 30 years.

I thought about Fisk’s homer and the ultimate heartbreak of Red Sox nation once again in 1975 when I read about several recent issues involving corruption and corporate responsibility for oversight, or perhaps more appropriately, the lack thereof. The first was an article in the New York Times (NYT), entitled “Another Scandal Hits Citigroup’s Moneymaking Mexican Division”, by Michael Corkery and Jessica Silver-Greenberg. Their article spoke about the continuing travails of Citigroup’s Mexican subsidiary Banamex. Back in February, the company revealed “a $400 million fraud involving the politically connected, but financially troubled, oil services firm Oceanografía.”

However, company investigators have unearthed another problem at the Mexico unit. The article reported “An internal investigation, begun by Citigroup in July, found evidence that the security unit was overcharging vendors and may have been taking kickbacks, a person briefed on the investigation said. The internal inquiry also found shell companies that had been set up to look like vendors and receive payments from the Banamex unit.” In a statement reported in the piece, Citigroup’s Chief Executive Officer (CEO) Michael L. Corbat “called the conduct of the individuals in the security unit ‘appalling’”.

What I found most interesting in the article was the response of Citigroup and what its implications might mean for the compliance practitioner, particularly one whose company is under scrutiny for a Foreign Corrupt Practices Act (FCPA) violation by the Department of Justice (DOJ) and Securities and Exchange Commission (SEC). The NYT piece made clear that the Mexico unit is so profitable that it figuratively “mints money” for the company. Moreover, “despite the latest headline-grabbing turmoil at Banamex, Citigroup does not want to cede any ground in Mexico where it dominates a large portion of the retail market.”

What is the responsibility for a US corporate parent when a foreign subsidiary ‘mints money’ for the company? Should the corporate parent pay closer attention to make sure the subsidiary is doing business in compliance with the FCPA and other relevant laws? In the past few posts, I have discussed some of the specific internal controls a compliance practitioner might consider for a company’s international operations. One of the problems Citigroup is facing with the conduct of its Mexico subsidiary is the company’s concern of “lax controls and oversight”. Moreover, there is concern that some part of the ongoing troubles in the Mexico unit relates to its head, Manuel Medina-Mora. Citigroup Chairman Michael O’Neill, was said to have “privately expressed concerns to board members that Mr. Medina-Mora, who is also co-president of the parent company, has not always relayed problems in the region to executives at the bank’s headquarters on Park Avenue, according to the people briefed on the matter. Instead of looping in executives in New York, Mr. Medina-Mora has at times chosen to handle the issues himself.”

How much oversight should a parent corporation have over a subsidiary? At a basic level it would seem that oversight should be enough to prevent and detect illegal conduct. Clearly, a Chief Compliance Officer (CCO) should be considering the entity-wide internal controls for a company. Under the FCPA accounting provisions, issuers can be held liable for the conduct of their foreign subsidiaries, even though the improper conduct occurred outside of the US. The scope of liability is based on the issuer’s incorporation of the subsidiary’s financial statements in its own records and SEC filings.

While a CCO should expect (and the DOJ & SEC for that matter) that internal controls at locations outside the US are of the same effectiveness as internal controls in US business units and at the US corporate office; unfortunately, that might not always be the case. It is often the case that corporate level internal controls are stronger than those in foreign business units. The Citigroup situation with its Mexican subsidiary would seem to be a clear example of the oft-cited reason that many companies were built through acquisitions, resulting in many business units (both in and outside the US) having completely different accounting and internal control systems than US corporate office. There is often a tendency to leave acquired companies in the state in which they were acquired, rather than trying to integrate their controls and conform them to those of current business units. After all, the reason for the acquisition was the profitability of the acquired company and nobody wants to be accused of negatively impacting profitability, especially one that ‘mints money’.

The second example is one a bit closer to home and it is that of the General Motors (GM) legal department. In an article in the Wall Street Journal (WSJ) entitled “GM Says Top Lawyer to Step Down”, John D. Stroll and Joseph B. White, with contributions from Christopher Matthews and Joann S. Lublin, reported that GM General Counsel (GC) Michael Millikin will retire early next year. Millikin was criticized after the GM internal investigation found that he ran the GM legal department in such a hands off manner that he did not know about his legal department’s own settlements for product liability claims involving faulty ignition switches until February of this year. His defense was that his own lawyers “left him in the dark” even though there was evidence that he had been repeatedly warned, “GM could face punitive damage awards related to its failure to address the safety defect.” Missouri Senator Claire McCaskill summed up sentiment about Milliken with her statement “This is either gross negligence or gross incompetence.” In other words if you are a GC or CCO you had better know what is going on in your own department. What would it say about a CCO who did not know that compliance department members were dealing with violations of the FCPA without informing him or her? It would say that the CCO failed to exercise leadership and oversight.

And while you are watching things closely, you may want to check out a clip of Carlton Fisk’s famous homer 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

Citibank: Multiple Failure of Compliance as the Hammer Drops

What is the cost of the failure to perform appropriate due diligence on a regular basis? What red flags should you look for when considering doing business with a customer, party in the sales channel or entity in the supply chain? All of these questions and more continue to swirl around Citigroup and its Mexican subsidiary Banamex over the ongoing investigation into allegations of fraud at Citi’s Mexico bank unit.

Citi had come to grief when there was a reported $400MM loss in Banamex involving the Mexican marine energy services company Oceanografía SA de CV. The problems arose after Banamex had extended $585MM in short-term credit to a company that Citi itself had warned its own bond investors was “from time to time subject to various accusations, including accusations of corrupt practices.” Oceanografía provided construction, maintenance and vessel-chartering services to the Mexican national energy company, Pemex’s exploration and production subsidiary. But Oceanografía’s fortunes, changed sharply in February of this year after it became the subject of a new government review that resulted in a suspension of Pemex contracts to Oceanografía for the next 20 months. Banamex had previously advanced as much $585 million to Oceanografía through an accounts receivable program, which would advance money to Oceanografía to provide services to Pemex. Pemex would then pay back Banamex, verifying invoices provided by Oceanografía to confirm that the work had been completed. In other words, Banamex was relying on Pemex’s ability to pay back the bank. But all of this ended when Pemex suspended its contracts with Oceanografía.

In a Wall Street Journal (WSJ) article, entitled “Citi Says Signs of Mexico Fraud Weren’t Escalated”, Christina Rexrode reported that Citi Chief Executive Officer (CEO) Michael Corbat told investors that employees “missed signs of trouble they should have recognized and elevated to superiors.” In a talk to investors Corbat was quoted as saying “There were telltales along the way” and he promised that “the bank would work on motivating and encouraging employees to raise their concerns when they notice potential problems.” But the problems ran deeper and were perhaps more systemic than simply the failure to escalate. Rexrode reported “People inside the bank have said the unit was allowed to operate as its own fiefdom, with New York employees struggling to get information about how the unit operated.” However, “A Citigroup spokesman said in a statement that “Banamex is absolutely subject to the same risk, control, anti-money-laundering and technology standards and oversight which are required throughout the company.””

These statements come on the heels of the dramatic firing of 11 Banamex employees just two weeks earlier. After meeting with the Citi Board of Directors, Corbat flew to Mexico City and terminated 11 employees. In an article in the New York Times (NYT), entitled “Citi Fires 11 More in Mexico Over Fraud”, Michael Corkery and Elisabeth Malkin reported that “Among those fired were four of the bank’s top executives in Mexico: its head of corporate banking, head institutional risk officer, head of trade finance and head of trade and treasury solutions. Some of the employees had worked at Banamex for as long as two decades and were not involved in the fraud directly. The bank fired many because they had not taken steps to detect the fraud or had ignored warning signs about the client.”

But apparently Citi expects there to be more disciplinary actions stemming form the matter. In an article in the Financial Times (FT), entitled “Citi fires 11 staff in Mexico unit”, Jude Webber, Camilla Hall and Kara Scannell reported that Corbat said in a memo to staff “Before our investigation concludes, we expect that several other employees, both inside and outside of Mexico, may receive forms of disciplinary action as well.” Two persons who may yet face such disciplinary action are “Manuel Medina-Mora, a Citi executive who oversees the Mexican operations and had his pay docked by $1.1m in March, or Javier Arrigunaga, Banamex chief executive.” Additionally, and perhaps more ominously for Citi, both the F.B.I. and prosecutors from the United States attorney’s office in Manhattan are investigating “Whether Citigroup willfully ignored possible warning signs”.

What red flags did Citi miss and for how long? One clue was reported in the NYT article, which noted that Oceanografía “is known among Mexican investors as politically connected but financially troubled. Credit rating firms in the United States, corporate bond investors and Mexican lawmakers have raised concerns about Oceanografía. In 2009, United States ratings firm Fitch warned about Oceanografía’s high leverage and poor cash flow generation. Fitch eventually withdrew its ratings because the company was not supplying enough information. In 2008, Standard & Poor’s noted that Mexico’s congress had investigated accusations of improper deals between Oceanografía and Pemex, though no wrongdoing was proved. Still, Oceanografía grew to become one of Banamex’s 10 largest corporate clients. The fraud erased 19 percent of the unit’s banking profits last year.”

These troubles were seemingly magnified in Mexico when the CEO of Oceanografía, Amado Yáñez Osuna, was arrested and charged with violating Mexican banking laws. In a WSJ article, entitled “Oil-Tinged Graft Scandal Roils Mexico”, Laurence Iliff and Amy Gutherie reported “The arrest deepens a scandal that has sent shock waves across Mexico’s political landscape. That put a spotlight on long-simmering allegations that the country’s former ruling National Action Party, known as PAN, used Pemex to favor Oceanografía and other contractors during the party’s 12 years in power, which ended with the 2012 election of President Enrique Peña Nieto of the Institutional Revolutionary Party (PRI).” Further, during those “12 years, Oceanografía’s contracts with the oil monopoly swelled from a few million dollars a year to hundreds of millions of dollars, according to a review of the contracts by The Wall Street Journal. Most of the contracts were obtained in public bids, although some were assigned directly without bids, including one contract for about $65 million in the final months of the Calderón administration.”

The case took a far more ominous turn when authorities when Mexican authorities announced last week that they had issued arrest warrants for multiple Banamex executives. In an article in the FT entitled, “Mexico issues fresh set of Banamex arrest warrants” Jude Webber reported that “Mexico has issues more arrest warrants – including an unspecified number for staff at Citigroup’s Banamex unit – a day after detaining the owner of the oil services company at the centre of a $400m alleged fraud scandal that has rocked the bank since its disclosure there months ago.” In an article in the NYT entitled, “Mexico Authorizes Arrests In Fraud at Citigroup Unit” Elisabeth Malkin and Michael Corkery reported, “Attorney General Jesús Murillo Karam of Mexico confirmed on Friday that the authorities were seeking the former executives. He declined to say how many were involved.” Yes, there are warrants, but I won’t say who,” Mr. Murillo Karam told reporters.” Apparently not even Citigroup knows whose arrests may be imminent.

What are the lessons for the compliance practitioner? Three keys points are controls, escalation and oversight. What type of internal controls, or lack thereof, allowed one company to obtain such credit on what were basically receivables financing? What about allowing the Banamex unit to basically run its own show with little to no oversight from the corporate headquarters? Corkery and Malkin reported, “Citigroup is keen to demonstrate to regulators and investigators in the United States and in Mexico that it is cracking down on its employees for not catching the fraud. But the breadth of the punishment could also suggest that the bank, despite assurances that the fraud is confined this case, has had widespread problems with controls and oversight across its Mexican unit.” Moreover, in his memo to staff, Corbat said, ““we are reviewing our controls and processes in Mexico and strengthening any area we think falls short of our global standards or best practices.”” Corbat also noted Citi was looking at ways to encourage employees to increase escalation of issues earlier.

Moreover with these now imminent arrests of Banamex executives, Citi may be facing more serious charges in the US. Leaving aside the inane argument of a ‘rogue business unit’ it may be that the US parent choose not to look too closely at its high-flying and very profitable Mexican subsidiary. If, as it seems from the newspaper accounts, that Oceanografía was well known for the business tactic of under-bidding for contract and then making up the differences in cost overruns, this may not bode well for the Banamex executives or Citigroup. Likewise if there was one company that Banamex did business with, which engaged in such behavior, there may other similarly situated companies once a detailed investigation of the Citigroup unit is concluded.

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