Great Structures Week V – The Tacoma Narrow Bridge Failure and Preventing Failure in Your Compliance Program

I conclude my Great Structures Week with a focus on structural engineering failures: suspension bridges and the challenges of wind in their construction and maintenance. I am drawing these posts from The Great Courses offering, entitled “Understanding the World’s Greatest Structures: Science and Innovation from Antiquity to Modernity”, taught by Professor Stephen Ressler. In his chapter on suspension bridges he notes that the “Tacoma Narrows Bridge was the third longest span in the world when it opened to the world, this month of July in 1940.” Yet it collapsed only four months later, in one of the most famous visual images of a bridge’s collapsing. This is due to the “inherent flexibility of cable as a structural form”. A bridge can move in longitudinal vibration, that is up and down and in torsion, where it twists from side-to-side.

Most people recognize unstiffened suspension bridges as old as man and engineering itself. It was not until the 1820s that serious study was brought to bear on the issue of wind-related collapse of suspension bridges. The initial solution was to simply use more weight to reinforce the span. However, while that solution did bring some stability, it reinforced damage as the structure became a textbook example of Newton’s Second Law of Motion, which states that the acceleration of an object is dependent upon two variables – the net force acting upon the object and the mass of the object; meaning that once a heavy weight is in motion, it is more resistant to deceleration.

Yet it was scientific methodology that led to the disaster with the Tacoma Narrows Bridge. An engineer named Leon Moisseiff had developed a theory that long spanned suspension bridges were heavy enough that they did not require stiffening trusses because “their mass stabilized them against wind-induced vibrations.” However this theory failed to take into account how air flows around a bridge and the “dynamic response of the structural system.” Ressler concludes this section by stating, “this case has become a classic symbol of the dangers of arrogance born of overconfidence in science-based design methods, and belt-and-suspenders engineering has made a bit of a comeback.”

I thought about the catastrophic failure of the Tacoma Narrows Bridge in the context of one of the greatest risks in Foreign Corrupt Practices Act (FCPA) compliance; that being third parties. Many non-compliance corporate employees assume that if a third party passes due diligence muster; they are in the clear. After all, you cannot stop a third party from making a bribe or other corrupt payment. Fortunately the Department of Justice (DOJ) does not take such a myopic view as many business types. Under the FCPA, a company is responsible for the actions of its third party representatives.

The real work around your third party compliance program begins after the contract is signed and it is in the management of the third party relationship. While the FCPA Guidance itself only provides that “companies should undertake some form of ongoing monitoring of third-party relationships”. Diana Lutz, writing in the White Paper by The Steele Foundation entitled “Global anti-corruption and anti-bribery program best practices”, said, “As an additional means of prevention and detection of wrongdoing, an experienced compliance and audit team must be actively engaged in home office and field activities to ensure that financial controls and policy provisions are routinely complied with and that remedial measures for violations or gaps are tracked, implemented and rechecked.”

Carol Switzer, writing in the Compliance Week magazine, set out a five-step process for managing corruption risks, which I have adapted for third parties.

1. Screen – Monitor third party records against trusted data sources for red flags.
2. Identify – Establish helplines and other open channels for reporting of issues and asking compliance related questions by third parties.
3. Investigate – Use appropriately qualified investigative teams to obtain and assess information about suspected violations.
4. Analyze – Evaluate data to determine “concerns and potential problems” by using data analytics, tools and reporting.
5. Audit – Finally, your company should have regular internal audit reviews and inspections of the third party’s anti-corruption program; including testing and assessment of internal controls to determine if enhancement or modification is necessary.

Additionally there several different functions in a company that play a role in the ongoing monitoring of the third party. While there is overlap, I believe that each role fulfills a critical function in any best practices compliance program. 

Relationship Manager

There should be a Relationship Manager for every third party which your company does business. The Relationship Manager should be a business unit employee who is responsible for monitoring, maintaining and continuously evaluating the relationship between your company and the third party.

Compliance Professional

Just as a company needs a subject matter expert (SME) in anti-bribery compliance to be able to work with the business folks and answer the usual questions that come up in the day-to-day routine of doing business internationally, third parties also need such access. A third party may not be large enough to have its own compliance staff so I advocate a company providing such a dedicated resource to third parties. This role can also include anti-corruption training for the third party, either through onsite or remote mechanisms. The compliance practitioner should work closely with the relationship manager to provide advice, training and communications to the third party. 

Oversight Committee

A company can have an Oversight Committee review documents relating to the full panoply of a third party’s relationship with the company. It can be a formal structure or some other type of group but the key is to have the senior management put a ‘second set of eyes’ on any third parties who might represent a company in the sales side. In addition to the basic concept of process validation of your management of third parties, as third parties are recognized as the highest risk in FCPA or Bribery Act compliance, this is a manner to deliver additional management of that risk.

After the commercial relationship has begun the Oversight Committee should monitor the third party relationship on no less than an annual basis. This annual audit should include a review of remedial due diligence investigations and evaluation of any new or supplement risk associated with any negative information discovered from a review of financial audit reports on the third party. The Oversight Committee should review any reports of any material breach of contract including any breach of the requirements of the Company Code of Ethics and Compliance. In addition to the above remedial review, the Oversight Committee should review all payments requested by the third party to assure such payment is within the company guidelines and is warranted by the contractual relationship with the third party. Lastly, the Oversight Committee should review any request to provide the third party any type of non-monetary compensation and, as appropriate, approve such requests.

Audit

A key tool in managing the relationship with a third party post-contract is auditing the relationship. I hope that you will have secured audit rights, as that is an important clause in any compliance terms and conditions. Your audit should be a systematic, independent and documented process for obtaining evidence and evaluating it objectively to determine the extent to which your compliance terms and conditions are followed.

Perhaps now you will understand why I say that managing the relationship of your third party’s is where the real work of your FCPA compliance program comes to the fore. It also demonstrates a key difference in having a paper compliance program and doing compliance. Having a paper compliance program is simple but doing compliance is not always easy; you have to work at it to maintain an effective program.

I hope that you have enjoyed this week’s offering based around some of the world’s greatest structures, their engineering concepts and innovations and how they all related to a best practices compliance program. I am a huge fan of The Great Courses offerings and if you are interested in learning in a great many areas it is one of the best resources available to you. For a more detailed discussion of how you can develop and implement a best practices anti-corruption compliance program, I hope you will check my book Doing Compliance: Design, Create, and Implement an Effective Anti-Corruption Compliance Program, which is available through Compliance Week. You can review the book and obtain a copy by clicking here.

For a dramatic video of the collapse of the Tacoma Narrows Bridge on YouTube, click here.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business, legal advice, or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates, and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The Author gives his permission to link, post, distribute, or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.

© Thomas R. Fox, 2015

The Sioux at Little Bighorn and Using Risk Going Forward

I recently wrote about the stupidity of General Custer and the defeat of his Calvary at Little Bighorn as a lead in for the failure to adequately assess and then manage risks in a Foreign Corrupt Practices Act (FCPA) compliance program. I received the following comment from a reader:

As a military history buff, I note that your comments on risk assessment reflect a very limited view of the battle. The Sioux made superb use of reconnaissance, fire and maneuver. The cavalry’s underestimation of the military skills of their Indian enemies were immediately assessed and dealt with aplomb and considerable skill. The great lesson to be learned from the Battle of the Little Big Horn is that there is great opportunity in exploiting the tactical stupidity of the overconfident. Reminds me of Napoleon and Prince Alexander at the Platzen Heights of Austerlitz. 

This comment made an excellent point that risk assessment and risk management are not simply to be viewed as negatives or a drag on business. These concepts are also valid in aiding companies to do business by exploitation of strategic risk. This point was driven home most clearly in the recent book by well-known risk management guru Norman Marks, entitled World-Class Risk Management. 

Marks’ thesis on this issue is that “It is essential that management take enough risk! If they take no risk, the organization will fail. So risk management is about taking the right risks for the organization at the desired levels, balancing the opportunities on the upside and the potential for harm on the downside” [emphasis in original]. I once heard former Chairman of Citigroup, John Reed say the reason a car has brakes is not to make it safer but so that you can drive faster. It is the same concept. FCPA compliance programs are often viewed as brakes on doing business. At best they slow things down and at worst the Chief Compliance Officer (CCO) is Dr. No from the Land of No.

However, as Marks points out in his chapter entitled “What is Risk and Why is Risk Management Important?”, it is a serious flaw to only see risk as a negative and indeed to limit risk management to the negative. He wrote, “Treating risk as only negative and overlooking the idea that organizations need to take risks in pursuit of their objectives. Effective risk management enables an organization to exploit opportunities and take on additional risk while staying in control and thereby, creating and preserving value.” He goes on to explain that a company should “understand the uncertainty between where we are and where we want to go so that we can take the right risks and optimize outcomes”.

These outcomes should be determined through an organization determining its risk appetite. Here Marks commented on the definition found in the COSO 2013 Framework for risk appetite by saying it is “the amount of risk, on a broad level, an organization is willing to accept in pursuit of value. Each organization pursues various objectives to add value and should broadly understand the risk it is willing to undertake in doing so.” As pointed out by the comment to my blog post on risk assessment and risk management, I focused on risks that were not properly assessed and not properly managed, leading to catastrophic results. But the comment pointed out that when properly used a risk assessment can lead to better management of risk and allow a company to take greater risk because it can manage the scenario more effectively. Marks stated this concept as “think of risk as a range: the low end is the minimum level of risk you are willing to take because you have the ability to accept risk, and recognize that taking the risk is essential to achieving your objective. The high end is the maximum level of risk you can afford to take.”

In the FCPA context, I think this is most clearly seen in the area of third party risk management. There are five steps to the lifecycle of third party management: (1) business justification; (2) questionnaire; (3) due diligence and its evaluation; (4) contract with compliance terms and conditions; and (5) post-contract management. If circumstances are such that you cannot fully perform all five steps to your satisfaction, this puts pressure on the remaining steps. In other words, while your risk may go up if one cannot be fully performed, it may well be that the additional risk can be mediated in another step.

The robustness of your third party risk management program can give you the ability to move forward and use third parties for a business advantage. Say you want to hire a royal family member from a certain foreign country as a third party representative. While at first blush this might seem to be prohibited under the FCPA, there are two Opinion Releases that hold that the mere hiring of a royal family member does not violate the FCPA. In Opinion Release 10-03 the Department of Justice (DOJ) reviewed the following factors of whether a Royal Family Member is a foreign governmental official, the factors were: “(i) how much control or influence the individual has over the levers of governmental power, execution, administration, finances, and the like; (ii) whether a foreign government characterizes an individual or entity as having governmental power; and (iii) whether and under what circumstances an individual (or entity) may act on behalf of, or bind, a government.”

Then in Opinion Release 12-01, the DOJ went further and added a duties test to what was believe to be a status test only. After initially noting that “A person’s mere membership in the royal family of the Foreign Country, by itself, does not automatically qualify that person as a “foreign official”” the DOJ goes on to reiterate its long held position that each question must turn on a “fact-intensive, case-by-case analysis” for resolution. The DOJ follows with a list of factors that should be considered. They include:

1. The structure and distribution of power within a country’s government;
2. A royal family’s current and historical legal status and powers;
3. The individual’s position within the royal family; an individual’s present and past positions within the government;
4. The mechanisms by which an individual could come to hold a position with governmental authority or responsibilities (such as, for example, royal succession);
5. The likelihood that an individual would come to hold such a position;
6. An individual’s ability, directly or indirectly, to affect governmental decision-making; and the (ubiquitous)
7. Numerous other factors.

Additionally the DOJ recognized some of the risk management techniques that had been put into place by the company requesting the Opinion. These risk management techniques were having a robust anti-corruption compliance program and requiring one from the third party that had employed the royal family member. There was full transparency by the US Company in hiring the royal family member. The compensation was disclosed, was within a reasonable range and was appropriate for the services delivered to the company and the contract between the parties had appropriate FCPA compliance terms and conditions.

I had initially thought that the import of Opinion Release 12-01 was creative lawyering to create a new test around the hiring of royal family member and foreign government officials. However re-reading it in light of the comment to my earlier blog post and of Marks’ book, it can also be seen as an example of how using risk management can be a positive for a business going forward. I would posit to CCOs or compliance practitioners there may be ways to do business in compliance with the FCPA if you think of using your FCPA compliance program as a way to better manage risk to do business rather than simply saying something will violate your compliance program without thinking through how such a compliance risk could be managed effectively.

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, 2015

Fraud and the Detection of the Sources for Bribery

 

In a recent White Paper authored by Peter Smith for OFS Portal, entitled “Procurement and Fraud in the Supply Chain”, where he examined “fraud linked to procurement and supply chain activities.” Smith focuses on where fraud can occur in the procurement process. From this starting point, he suggests “mitigating actions that organisations can take to protect themselves against fraud.” I found this article to be an excellent review of Supply Chain (SC) activities which the Chief Compliance Officer (CCO) or compliance practitioner could put to good use in reviewing their company’s Foreign Corrupt Practices Act (FCPA) anti-corruption and anti-bribery regime.

A. The Problem – How Does Fraud Happen?

Smith starts by classifying fraud in way which will assist the reader in understanding how it occurs. He believes there are “three critical factors to consider: the perpetrator(s), the plan and the point of failure.” The perpetrator is the one “behind the fraud and either executes it directly or through others.” In the anti-corruption world of the FCPA, this can be through an agent or a supplier who is working to help execute the fraud.

Interestingly, in the area of these third parties (and hence the greatest area of risk for FCPA compliance practitioners to consider) Smith notes that “The plan and point of failure factors are linked in that often the plan relies on the point of failure. In other words, most frauds take advantage in some weakness in the process, technology, policy or systems of combination of those.” Smith writes that there are three key phases “in the procurement life-cycle that can be considered; (1) the supplier selection phase; (2) the contract negotiation and award phase; and (3) the contract delivery management phase.”

Phase I – Supplier Selection and Qualification

This phase should be well known to the compliance practitioner as a part of the third party life-cycle management step denominated as due diligence. But Smith asks that you consider factors other than simply whether someone is on the Denied Parties List (DNP) or is a Politically Exposed Person (PEP). He suggests that you consider misrepresentation by the third party in the nature of “concealing the true nature of its business, history or ownership when it bids for the work.” He also points out that through collusion and cartels, persons or entities can work to control a market. If you did any work with Petrobras over the years, you will certainly recognize that many if its approved suppliers operated in this manner. Given what we now know about how corrupt Petrobras was, this is not too surprising.

But Smith also suggests that employees may be involved in skewing the selection process towards a corrupt agent or other partner. He recommends reviewing the bid process to see if there was bias in the competition, which would push an otherwise arms-length award to a corrupt partner. This could occur through biased competition through specification, where an employee would “construct a specification that makes it likely or inevitable that a particular supplier will win the competitive process.” The next is biased competition through tailoring the evaluation process which gives weight to the specific strengths of a corrupt third party. Finally, Smith points out that there can be biased competition through information leakage when a company employee will leak confidential information to a third party to give them an advantage in the bidding process.

Phase II – Contracting

Smith says the “next critical point at which fraud can take place is during the contract negotiations and in agreeing the detailed terms and conditions.” Moreover, Smith believes this stage is critical if often overlooked because “the seeds are often sown at the contracting stage.” Scenarios can include where there is a certain level of ‘local content’ required “but without any clear contractual mechanism to explain how it will be measured or policed.” As any CCO or other FCPA compliance practitioner would recognize, local content is one of the easiest ways to get into FCPA high risk so managing that risk is critical. I found Smith’s concern with setting out the clear legal terms and conditions around any such requirement as a good way to manage the high risk.

Phase III – Contract Delivery and Management

Here Smith laid several different fraud schemes which could facilitate a bribery plan. The first is fake invoices which can rely on “poor processes within an organisation” to spot. However this scheme can also rely on a company insider to approve such fabrications. Next is “volume over-invoicing”. In this scheme, while a supplier does supply some goods or services, the invoice is raised for more than has been delivered. If there is a scheme to create a pot of money to be used to fund bribes, there will need to be an internal company accomplice to “smooth the way by authorizing receipts or invoices.” Next there is “price-related over-invoicing” the third party will over-price the goods or services, above what is allowed under the contract. Another scheme set out by Smith is “invoice diversion” where “a legitimate payment that should go to a certain supplier is diverted to a third party fraudulently.” Another scheme can simply be to ease the contract terms and conditions which allow the third party to receive a benefit with nothing in return being delivered back to the company. Finally, there is what Smith details as one of the “toughest frauds to detect”, that being the delivery of lower quality products than is contractually specified.

B.The Solution – How to Reduce Fraud

Smith believes that fraud prevention can be built around a troika of concepts. (1) You need to have “effective procurement and spend management policies in place. (2) You must “use appropriate and robust processes”. (3) Finally “applying the right technology to support and manage those processes.” In his paper he followed the same outline on how to reduce the instances of fraud.

Phase I – Supplier Selection and Qualification

While a clear procurement policy is the starting point, it is only the starting point. Having a transparent process is important as well as adequate supplier qualification details. He notes that multiple sign-offs should be in place to ensure that one person does not control the entire process. This should also be incorporated into the communications trail with the competitors to ensure that no one third party receives confidential information. Obviously an appropriate level of due diligence should be applied to confirm that not only are the third party’s who they represent themselves to be but that they are also qualified to do the work or deliver the services. Finally, there should be controls around onboarding “so that firms who are actually going to be suppliers go through more rigorous checks before they are accepted onto” the Vendor Master List.

Phase II – Contracting

Obviously the starting point for any business relationship should be a well-drafted contract. However, for larger organizations Smith believes that “a contracts database or contract lifecycle management system is essential.” To the greatest extent possible there should be standard compliance and legal terms and conditions, coupled with an “appropriate level of sign-off and approvals management for contracts.” Finally, segregation of duties (SOD’s) “to make sure that there are checks and balances and that no one person holds too much power in the process.”

Phase III – Contract Delivery and Management

As I often say in the lifecycle management of third parties, the real work begins when the contract is signed. Smith believes that many of the routes of fraud, “can be closed off by taking a few precautions” which include some of the following steps. First and foremost is “no purchase order, no pay” but this also means there should be an invoice from the vendor which is matched to the contract for accuracy. Once again checks and balances, SOD’s for sign-offs and approvals must be built into your payment system. There should be controls around changes to the contract and, more importantly, changes to any payment details. Lastly, ongoing oversight and monitoring through controls analytics and auditing should be employed on the back end to verify delivery of goods or services.

I found Smith’s White Paper to be an excellent review for the CCO or compliance practitioner around not only the mechanism of how fraud occurs but a review of the techniques for fraud prevention. While his concepts may seem like a review for the compliance practitioner, it also allows you to think through how corruption might take place in your organization. The briber has to get the money from some source and Smith’s White Paper can give you insights on where you might look.

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, 2015

 

Doing Compliance in an Economic Downturn, Part IV – Testing, Peer Groups and Talent Development

Today we celebrate the conquest of what the Tibetans call “Mother Goddess of the Land” and what the rest of us call Mount Everest. For on this date in 1953, Sir Edmund Hillary of New Zealand and Tenzing Norgay, a Nepalese Sherpa, became the first explorers to reach the summit of the highest point on earth. News of the success was rushed by runner from the expedition’s base camp to the radio post at Namche Bazar, and then sent by coded message to London, where Queen Elizabeth II learned of the achievement on June 1, the eve of her coronation. The next day, the news broke around the world. Later that year, Hillary and Norgay were both honored by the queen for their momentous achievement.

One of the things that made Hillary and Norgay’s ascent to the summit of Everest was the overall integration and teamwork of the entire group. The British team was led by Colonel John Hunt who set up a series of camps, allowing the expedition to push its way up the mountain in April and May. A new passage was forged through several previously un-surmounted obstacles to bring the team to about 26,000 feet. The first assault to the summit was launched on May 26 by Charles Evans and Tom Bourdillon, however they had to abandon their assent 300 feet from the top due to malfunctioning oxygen sets. Three days later, Hillary and Norgay were successful. In other words, teamwork and process were key to their success.

The accomplishment achieved by Hillary and Norgay drives the conclusion of my series on the steps you can take to improve your Foreign Corrupt Practices Act (FCPA) anti-corruption compliance program and overall compliance function during a period of economic downturn. So when faced with reduced monetary resources and lessened head count you might want to consider the teamwork of compliance. To that end you might use a strategy of developing compliance talent and relationships for the compliance function. You could initiate a compliance talent development group where you rotate high potential individuals in your company through the compliance function in some manner.

My suggestion would be to work with senior management and your Human Resources (HR) function to identify some of the key talent within your company. They can come from any other area of the company; such as accounting, finance, internal audit, HR itself, sales or any other discipline. From there you can task them to lead a working group on a compliance related project. The project itself can be any project you would like to try and implement when funding becomes more available.

One company I worked at had such an organization called the President’s Team which was an annual group that developed projects for the company Chief Executive Officer (CEO). The concept is the same but the goal is having the high talent employees learn more about compliance. Equally important for you as the compliance practitioner is to develop relationships with such up and comers so you can access to them if they continue to progress up the corporate chain. Remember it is important to have relationships with those in power and those who will be in power.

In addition to the talent development group, you should also revisit your interactions with your Board or Audit Committee. You need to re-emphasize to them their responsibility for compliance going forward and that it will not diminish simply because the price of oil has gone south or any other reason why you may be in an economic downturn. If there are emergency projects or others which you believe should take priority this would be a good time to inform and educate the Board on them so that you can continue to maintain as much funding as is possible. This could come into play if you have a number of whistleblower complaints to triage and review in short order due to employee layoffs. But if you did not establish those relationships ‘yesterday’, you probably cannot call on them ‘tomorrow’ so you need to make sure they are in place now.

Another idea that you can try is something along the lines of a client advisory committee or peer group review. You can put together a peer group to help advise your compliance function. After all, one of your constituent groups is your employee base. So why not turn to that group to find out what is working and perhaps their views on what is not, in their eyes, from the compliance function. If they can provide feedback to you on how to streamline a compliance process you might well be able to incorporate such suggestions going forward. They will be aware of the resource constraints the company is under so it could be an avenue which you have not previously used. Further, as with the talent development group concept, you would have the opportunity to develop relationships with other leaders in your organization. Finally, the group would have greater investment in the compliance function going forward.

Next is one of your highest risks, that of third parties, which most compliance practitioners recognize as their highest risk in any FCPA anti-corruption compliance program. This risk does not lessen simply because of a downturn. My suggestion is that you test and review all of the indicia around the lifecycle of your third party risk management program. This is not a forensic audit or even standards that an auditor might use. But you can test and you can test the documentation around your program at little to no cost.

The lifecycle of a third party is the following: (1) Business justification, (2) Questionnaire, (3) Due Diligence and Evaluation, (4) Contract negotiation, and (5) Managing the relationship thereafter. You can perform testing on all of these steps by reviewing the documentation in your third party database. For each third party you should confirm that there is documentation in each file, which supports each of the five prongs. In addition to the document, document, document aspect of this exercise, you can also use it as a cross-check on your internal control mapping for each validated prong so this can also be considered an internal compliance control.

I hope that you have found some of these ideas for improving your compliance function in an economic downturn useful. Perhaps they have stimulated ideas or discussions within your organizations going forward. If you have any other ideas which you would be willing to share, I hope that you will pass them along to me. We are all in this compliance ride together anything we all can do to move things forward is progress in my mind.

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, 2015

Levi Strauss and Auditing of Third Parties

Today we celebrate innovation. On this day in 1873, a patent to create work pants reinforced with metal rivets was granted. This marked the birth of one of the world’s most famous garments: the blue jeans. Jacob Davis, a tailor in Reno, Nevada, presented the idea to Levi Strauss in 1872 when he wrote Strauss a letter about his method of making work pants with metal rivets on the stress points to make them stronger. Davis didn’t have the money for the necessary paperwork and proposed that Strauss provide the funds and that they get the patent together. Strauss agreed and the patent for “Improvement in Fastening Pocket-Openings”, the innovation that would produce blue jeans, was granted.

Until Strauss opened a factory in 1880 the “waist overalls”, as the original jeans were known, were manufactured by seamstresses working out of their homes. Levi’s 501’s, previously known as “XX”, were soon a bestseller, and by the 1920s they were the top-selling work pant in the US. Over the decades the fad has grown and today they are a firm staple in closets around the globe.

I thought about this innovation and sustained excellence when I sat through a presentation at Compliance Week 2015 by two ladies from BakerHughes Inc. (BHI) Jennifer Ellison, Senior Legal Compliance Manager, and Marianne Ibrahim, Senior Counsel, on Audits and Investigations. They focused on three aspects of the company’s audit program in its compliance function, types and purpose of Foreign Corrupt Practices Act (FCPA) audits, planning for the audit and interviewing all in conjunction with your audit program for third parties.

When planning for such an audit they laid out the following steps. You should plan out four to six weeks in advance, you should perform the audit with your legal counsel’s lead to preserve privilege, work with the business sponsor to establish key business contacts, discuss audit rights and processes with the third party, you should prepare initial document request lists for financial information queries, take the time to review findings from previous audits and resolutions and also review details of opened and closed internal investigations, if there are any Code of Conduct questionnaires available take care to review and finally be cognizant of any related Department of Justice (DOJ) and Securities and Exchange Commission (SEC) enforcement actions.

They noted you should try and determine the entry points of foreign government involvement. They broke this down into (1) direct and (2) indirect. In the direct category they listed the following areas: customs and duties, corporate taxes and penalties, social security or national insurance issues for employees, obtaining in-country visas and work permits, public official gifts and entertainment, training of and attendant travel for employees of government owned entities, procurement of business licenses and permits to perform work and, finally, areas around police escort and security. In the indirect category, some of the key areas to review are: customs agents and freight forwarders, visa processors, commercial sales agents, including distributors and, finally, those who might be consultants or other channel partners.

Document review and selection is important for this process. They said that you should ask for as much electronic information as possible well in advance of your audit. They did recognize that it is much easier to get database records for internal audits than audits of third parties. One item they made sure to ask for in advance was records in database or excel format and not simply in .pdf. They suggested you ask for the following categories of documents; trial balance, chart of accounts, journal entry line items, financial and compliance policies, prior audited financial statements, bank records and statements, a complete list of agents or intermediaries and revenue by country and customer.

When you are ready to commence your interviews, they emphasized that the lead interviewer needs to be culturally sensitive, patient and must negotiate a good working relationship with auditors, who will be reviewing the documents from the forensic perspective. Regarding potential interviewees, they related you should focus on those who interact with government entities, foreign government officials or third parties, including those personnel involved with:

• Business Leadership
• Sales/Marketing/Business Development
• Operations
• Logistics
• Corporate Functions: Human Resources, Finance, Health, Safety and Environmental, Real Estate and Legal.

For the interview topics, they suggested several lines of inquiry. Initially they noted you should conduct the audit interview as precisely that, an audit interview and not an investigative interview. You should not play ‘got-cha’ in this format. They said you should avail yourself of the opportunity to engage in training while you are interviewing people. The topics to interview on included:

• General policies and procedures
• Books and records pertaining to FCPA risks;
• Test knowledge of FCPA and UK Bribery Act including facilitating payments and their understanding of your company’s prohibitions;
• Regulatory challenges they may face;
• Any payments of taxes, fees or fines;
• Government interactions they have on your behalf; and
• Other compliance areas you may be concerned about or that would impact your company, including: trade, anti-boycott, anti-money laundering, anti-trust.

Ellison and Ibrahim went into detail regarding the review you should make around the General Ledger (GL) accounts. They suggested you review commission payments to agents and representatives, any facilitating payments made, all payments around travel, meals and entertainment, payments made around training, gifts, charitable contributions, political donations and sales and promotion expenses. If there were payments made for customs or freight forwarders and other processing agents, permits, licenses, taxes and other regulatory expenses should be reviewed. Additionally any entries pertaining to community contributions and social responsibility payments should be assessed and, finally, they suggested that a review of any security payments, extortion payments, payments to legal consultants or tax advisors or fines and penalties should be considered.

Regarding bank accounts and cash disbursement controls, you should review the following:

• Review controls around bank accounts and cash disbursements;
• Identify and review authorized signers, approval levels, and bank reconciliations;
• Ensure all bank accounts are included in the General Ledger;
• Identify and review certain bank and cash disbursement transactions;
• Identify offshore bank accounts.

In the area of cash funds review the following:

• Review controls around petty cash funds;
• Ascertain processes in place regarding disbursement and reconciliation of cash funds;
• Identify and review payments to government officials, agents, or any unusual or suspicious activities; and
• Identify and review certain bank transactions and test for any improper payments.

For gifts, travel and entertainment, you should explore payments made through employee-reimbursed expenses, scrutinize for any suspicious expenses submitted, expenses lacking adequate documentation, incorrect posting; and identify and review accounts associated with gifts, meals, entertainment, travel, or promotion. In the area of payroll, consider the risks around the use of ghost employees, hiring of relatives of government employees, and the use of bonus payments and be sure to request a payroll listing and review for any such persons.

Around training you should determine whether your company provides industry specific training to government entities, and review GL accounts and expenses for related items. In taking a look at payments under local law, you should obtain list of payments to the government required by local laws and identify and review payments to government authorities or employees, customs authorities or agents, income taxes authorities or license requirements. For payments made to third parties, you should review commission and expense payments for compliance with company policy and also trace payments to the third party’s bank account.

Ellison and Ibrahim provided solid, detailed information on not only what your audit protocol should be but also provided material on what you should look for and how you should do it. It was an excellent presentation.

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, 2015

Managing Your Third Parties in a FCPA Compliance Program

The building blocks of any Foreign Corrupt Practices Act (FCPA) anti-corruption compliance program lay the foundations for a best practices compliance program. For instance in the lifecycle management of third parties, most compliance practitioners understand the need for a business justification, questionnaire, due diligence, evaluation and compliance terms and conditions in contracts. However, as many companies mature in their compliance programs, the issue of third party management becomes more important. It is also the one where the rubber meets the road of actually doing compliance.

In the March/April issue of Supply Chain Management Review is an article by Mark Trowbridge, entitled “Put it in Writing: Sharpening Contracts Management to Reduce Risk and Boost Supply Chain Performance”, that provides some useful insights into the management of the third party relationship. While the focus of the article was about having a “strategic approach to contracts management” I found the author’s “five ways to start professionalizing your approach to outsourcing contracts” as steps a compliance practitioner can use in the management of third party relationships, both on the sales side and those which come into your company through the Supply Chain.

By taking his analysis into the compliance realm, I believe there are concrete steps you can take going forward. The key is to have a strategic approach to how you structure and manage your third party relationships. This may mean more closely partnering with your third parties to help manage the anti-corruption compliance risk. It would certainly lead towards enabling your company to “control risk while optimizing the performance” of your third parties. To achieve these goals, I have revised Trowbridge’s prescriptions from suppliers to third parties.

I. Consolidate Third Parties but Retain Redundancy

It is incumbent that consolidation in your third party relationships on the Supply Chain side to a smaller number of suppliers will “yield better cost leverage.” From the compliance perspective it also should make the entire third party lifecycle easier to manage, particularly steps 1-4. However a company must not “over-consolidate” by going down to a single source supplier. Trowbridge advocates a diversified supplier base, with a technique he calls “dual-sourcing”. From the compliance perspective, you may want to have a primary and secondary third party that you work with in a service line or geographic area to retain this redundancy.

II. Keep Tabs on Subcontracted Work

This is one area that requires an appropriate level of management. If your direct contracting party has the right or will need to subcontract some work out, you need to have visibility into this from the compliance perspective. You will need to require and monitor that your direct third party relationship has your approved compliance terms and conditions in their contracts with their subcontractors. You will also need to test that proposition. In other words, you must require, trust and then verify.

III. When Disaster Strikes, Make Sure Your Company is Legally Protected Too

This is where your compliance terms and conditions will come into play. One of the things that I advocate is a full indemnity if your third party violates the FCPA and your company is dragged into an investigation because of the third party’s actions. Such an indemnity may not be worth too much but if you do not have one, there will be no chance to recoup any of your legal or investigative costs. Another important clause is that any FCPA violation is a material breach of contract. This means that you can legally, under the terms of the contract, terminate it immediately, with no requirement for notice and cure. Once again you may be somewhat constrained by local laws but if you do not have the clause, you will have to give written notice and an opportunity to cure. This notice and cure process may be too long to satisfy the Department of Justice (DOJ) or Securities and Exchange Commission (SEC) during the pendency of a FCPA investigation. Finally, you need a clause that requires your third party to cooperate in any FCPA investigation. This means cooperation with you and your designated investigation team but it may also mean cooperation with US governmental authorities as well.

You also need the ability to move between third parties if the need arises. This is the redundancy issue raised above. You do not want to be stuck with no approved freight forwarders or other transporters in a certain geographic area. If a compliance related matter occurs, you may well need certain contractual rights to move your work and to require your prime third party to cooperate with the transition to your secondary third party.

IV. Keep Track of Your Third Parties’ Financial Stability

This is one area that is not usually discussed in the compliance arena around third parties but it seems almost self-evident. You can certainly imagine the disruption that could occur if your prime third party supplier in a country or region went bankrupt; but in the compliance realm there is another untoward Red Flag that is raised in such circumstances. Those third parties under financial pressure may be more easily persuaded to engage in bribery and corruption than third parties that stand on a more solid financial footing. You can do this by a simple requirement that your third party provide annual audited financial statements. For a worldwide logistics company, this should be something easily accomplished.

Trowbridge says, “Automated financial tracking tools can also be used to keep track of material changes in a supplier’s financial stability.” You should also use your in-house relationship manager to regularly visit key third party relationships so an on-the-ground assessment can be a part of an ongoing conversation between your company and your third parties.

V. Formalize Incentives for Third Party Performance

One of the key elements for any third party contract under the FCPA or UK Bribery Act is the compensation issue. If the commission rate is too high, it could create a very large pool of money that could be used to pay bribes. It is mandatory that your company link any commission or payment to the performance of the third party. If you have a long-term stable relationship with a third party, you can tie compensation into long-term performance, specifically including long-term compliance performance. This requires the third party to put skin into the compliance game so that they have a vested, financial interest in getting things done in compliance with the FCPA or other anti-corruption compliance regime.

Additionally, as Trowbridge notes, “The fact is, linking contractual compensation to performance does make a significant difference in supplier performance. This is especially valuable when agreed upon key performance indicator (KPI) metrics can be accurately tracked.” This would seem to be low hanging for the compliance practitioner. If you cannot come up with some type of metric from the compliance perspective, you can work with your business relationship team to develop such compliance KPIs.

While Trowbridge’s article focused on the suppliers, I found his ideas easily transferable to the compliance field. Near the end of the article Trowbridge suggested ranking suppliers based upon a variety of factors including performance, length of relationship, benchmarking metrics and KPIs. This is a way for the compliance practitioner to have an ongoing risk ranking for third parties that can work as a preventative and even proscription prong of a compliance program and allow the delivery of compliance resources to those third parties that might need or even warrant them.

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, 2015

Supply Chain as a Source of Compliance Innovation

On this day we celebrate the greatest upset in the history of the NCAA Basketball Tournament, when Villanova beat Georgetown for the 1985 national championship. Georgetown was the defending national champion and had beaten Villanova at each of their regular season meetings. In the final the Wildcats shot an amazing 79% from the field, hitting 22 of 28 shots plus 22 of 27 free throws. Wildcats forward Dwayne McCain, the leading scorer, had 17 points and 3 assists. The Wildcats’ 6’ 9” center Ed Pinckney outscored 7’ Hoyas’ center, Patrick Ewing, 16 points to 14 and 6 rebounds to 5 and was named MVP of the Final Four. It was one of the greatest basketball games I have ever seen and certainly one for the ages.

I thought about this game when I read an article in the most recent issue of Supply Chain Management Review by Jennifer Blackhurst, Pam Manhart and Emily Kohnke, entitled “The Five Key Components for SUPPLY CHAIN”. In their article the authors asked “what does it take to create meaningful innovation across supply chain partners?” Their findings were “Our researchers identify five components that are common to the most successful supply chain innovation partnerships.” The reason innovation in the Supply Chain is so important is that it is an area where companies cannot only affect costs but can move to gain a competitive advantage. To do so companies need to see their Supply Chain third parties as partners and not simply as entities to be squeezed for costs savings. By doing so, companies can use the Supply Chain in “not only new product development but also [in] process improvements”.

I found their article resonated for the compliance professional as well. It is almost universally recognized that third parties are your highest Foreign Corrupt Practices Act (FCPA) risk. What if you could turn your Supply Chain from being considered a liability under the FCPA to an area that brings innovation to your compliance program? This is an area that not many compliance professionals have mined so I think the article is a useful starting point. The authors set out five keys to successful innovation spanning Supply Chain partners. They are: “(1) Don’t Settle for the Status Quo; (2) Hit the Road in Order to Hit Your Metrics; (3) Send Prospectors Not Auditors; (4) Show Me Yours and I’ll Show You Mine; and (5) Who’s Running the Show?”

Don’t Settle for the Status Quo

This means that you should not settle for simply the status quo. Innovation does not always come from a customer or even an in-house compliance practitioner. Here the key characteristics were noted to be “cooperative, proactive and incremental”. The authors emphasize that “you need to be leading the innovation change rather than catching up from behind.” If a company in your Supply Chain can suggest a better method to do compliance, particularly through a technological solution, it may be something you should well consider.

Hit the Road in Order to Hit Your Metrics

To truly understand your compliance risk from all third parties, including those in the Supply Chain, you have to get out of the ivory tower and on the road. This is even truer when exploring innovation. You do not have hit the road with the “primary goal to be the inception point for innovation” but through such interactions, innovation can come about “organically”. There is little downside for a compliance practitioner to go and visit a Supply Chain partner and have a “face-to-face meeting simply to get to know the partner better and more precisely identify that partner’s needs.”

Send Prospectors Not Auditors

While an audit clause is critical in any Supply Chain contract, both from a commercial and FCPA perspective, the authors believe that “Too often firms use supply chain managers as auditors when they are dealing with supply chain partners.” The authors call these types of managers “innovation partners.” Every third party should have a relationship manager, whether that third party is on the sales side or the Supply Chain side of the business. Moreover, the innovation partners are “able to see synergies where [business] partners can work together for the benefit of everyone involved.”

Show Me Yours and I’ll Show You Mine

Here the authors note, “Trust plays an extremely important role in supply chain innovation. Firms in successful innovations discussed a willingness to share resources and rewards and to develop their partners’ capabilities.” The authors believe that “Through the process of developing trust, firms understand their partner’s strategic goals.” I cannot think of a more applicable statement about FCPA compliance. Another way to consider this issue is that if your Supply Chain partner has trust in you and your compliance program, they could be more willing to work with you on the prevent and detect prongs of compliance regimes. Top down command structures may well be counter-productive.

Who’s Running the Show?

I found this point particularly interesting as for the authors, this prong means “who is doing what, but also what each firm is bringing to the relationship in terms of resources and capabilities.” In the compliance regime it could well lead to your Supply Chain partner taking a greater role in managing compliance in a specific arena or down a certain set of vendors. Your local Supply Chain partner might be stronger in the local culture, which could allow it to lead to collaborations by other vendors in localized anti-corruption networks or roundtables to help move the ball forward for doing business in compliance with the FCPA or other anti-corruption laws such as the UK Bribery Act.

The authors ended by remarking, “we noticed that leveraging lean and process improvement was mentioned by virtually every firm.” This is true in the area of process improvement, which is the essential nature of FCPA compliance. Another interesting insight from the authors was that utilization can increase through such innovation in the Supply Chain. Now imagine if you could increase your compliance process performance by considering innovations from your Supply Chain third parties? The authors conclude by stating that such innovation could lead to three “interesting outcomes 1) The trust and culture alignment is strengthened through the partnership innovation process leading to future innovations and improvement; 2) firms see what is needed in terms of characteristics in a partner firm so that they can propagate the success of prior innovations to additional partners; 3) by engaging supply chain partners as innovation partners, both sides reap rewards in a low cost, low risk, highly achievable manner.” With some innovation Villanova coach Rollie Massimino led his team over the prohibitive favorite Georgetown, and you may be able to tap into a resource immediately available at your fingertips, your Supply Chain.

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, 2015

Selfie-Sticks and Risk Assessments

Greetings from Venice and a big thanks to Joe Oringel at Visual Risk IQ for allowing my to post his five tips on working with data analytics while I was on holiday in this most beautiful, haunting and romantic of cities. While my wife and I have come here several times, we somehow managed to arrive on the first weekend of Carnivale, without knowing when it began. On this first weekend, the crowds were not too bad and it was more of a local’s scene than the full all out tourist scene.

As usual, Venice provides several insights for the anti-corruption compliance practitioner, whether you harbor under the Foreign Corrupt Practices Act (FCPA), UK Bribery Act, both, or some other such law. One of the first things I noticed in Venice was the large number of selfie-sticks and their use by (obviously) tourists. But the thing that struck me was the street vendors who previously sold all manner of knock-off and counterfeit purses, wallets and otherwise fake leather goods had now moved exclusively to market these selfie-sticks. Clearly these street vendors were responding to a market need and have moved quickly to fill this niche.

While the economics, inventory, bureaucracy, market-responsiveness of such businesses may be a bit more nimble than the more traditional US entity doing business overseas it does bring up a very good lesson for the compliance practitioner. A risk assessment is a tool for a variety of purposes. Certainly moving into a new geographic area is an important reason to perform a risk assessment. However, it can also be used for a new product offering, such as a selfie-stick. As stated in the FCPA Guidance, “As a company’s risk for FCPA violations increases, that business should consider increasing its compliance procedures, including due diligence and periodic internal audits. The degree of appropriate due diligence is fact-specific and should vary based on industry, country, size, and nature of the transaction, and the method and amount of third-party compensation. Factors to consider, for instance, include risks presented by: the country and industry sector, the business opportunity, potential business partners, level of involvement with governments, amount of government regulation and oversight, and exposure to customs and immigration in conducting business affairs. When assessing a company’s compliance program, DOJ and SEC take into account whether and to what degree a company analyzes and addresses the particular risks it faces.”

So what if your company comes to market with a new product or, in the case of the Venetian street merchants, move to sell a product for the first time even if the product is not exactly ‘new’. Obviously you will need to consider all government touch points that could bring you into potential violation under the FCPA. You should determine not only what licenses you will need but also how you will obtain them. Avon has come to over $500MM in FCPA grief by paying bribes to obtain licenses (and then doubling down by going full Watergate in its cover-up). Wal-Mart is alleged to have gotten into hot water in Mexico for paying bribes to obtain permits to do business in that country. So will your company obtain these licenses directly or use a third party to obtain them?

What about continued quality control of your new product? If you are in the food product industry this will mean continued inspections of your products to assure they meet government standards. Make sure that you have a hiring process in place to weed out the wives, sons or daughters of any food service inspectors. Of course, do not hire such inspectors for jobs directly either, especially if they do not have to show up or perform any duties to get paid by your company.

If you are not going to manufacture your selfie-stick equivalent in the country where these new products will be sold, how will you import them? Who will be interfacing with the foreign government on tax issues for importing of products? Will they be there permanently or on a temporary basis? All questions that have gotten US companies into FCPA trouble when they paid bribes to answer, assuage or grease some or all of the answers.

It turns out the compliance practitioner can learn quite a bit from the selfie-stick; not all of it is simple self-indulgence. Your compliance program must respond to your business initiatives. To do so, you also need to have a seat that the big boy table where such initiatives are discussed. But that is another lesson from Venice for a different day. Until then, ciao.

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, 2015

The Avon FCPA Settlement, Part II

I am back from my holiday break and am looking forward to many good ideas for blogs in the coming year. However before we get to 2015, I have to finish out some matters from 2014. Today I continue my look at the Avon Foreign Corrupt Practices Act (FCPA) enforcement action, which was announced earlier this month. In today’s post I will look at the bribery scheme and cover-up that Avon employed. Tomorrow I will conclude with some final lessons to be gleaned from the Avon enforcement action for both the compliance practitioner and greater corporate world. Avon Products (China) Co. Ltd. is referred to as ‘Avon China’ and Avon Products, Inc. (the US parent) is referred to as ‘Avon’.

With a sustained plan that one can only say was well thought out, Avon set out to conquer the Chinese market for door-to-door sales. To do so, Avon had to navigate a bureaucratic maze. This maze began with a Test License obtained in 2005 and later a national direct selling license together with approvals from each province and municipality where the company wanted to sell its products. To obtain the required licenses, the company set a bribery scheme which worked at all levels of the company’s China subsidiary, Avon China, and reached back to the home office in the US, Avon Products. Both of these entities were the subject of the FCPA enforcement action concluded earlier this month. The bribery scheme itself paid out over $8MM in bribes before it was concluded.

To facilitate this process Avon China set up a business unit entitled the Corporate Affairs Group and later a more focused sub-group as part of the scheme called the Direct Selling Special Task Force. These two groups led the company’s efforts to bribe its way into the China market. They did so through a variety of means, as set out in the settlement documents. Unless cited otherwise, the quotes below are from the Avon China Criminal Information.

Gifts

Avon was fond of giving very high priced gifts to various Chinese government officials. Inevitably, Avon China employees would falsely describe the gift itself in the company’s books and record. To add to this deception, Avon China would omit from the books and records not only who the gift was provided to but also the purpose of the gift. This part of the bribery scheme allowed the gifts of Louis Vuitton products to be described as a “public relations expense” and “Public Relations Business Entertainment”; while the gift of a Gucci bag was described as “business entertainment”.

Meals and Entertainment

This part of the bribery scheme was a clear favorite of Avon China. The aforementioned Direct Selling Special Task Force was ubiquitous in the meals and entertainment arena where its members simply used the term “relations” to refer to “things of value provided to government officials or goodwill that had been obtained by giving such things, including non-business meals and entertainment.” Specifically noted in this part of the bribery scheme were payments of approximately $8,100 described as “sales-business entertainment” provided to a government official so he would approve a product that did not meet Chinese government standards. Other false excuses provided were describing such payments as “business entertainment” and “employee ‘accommodation’ expenses”.

Non-Business Travel

Avon China doled out a huge amount of bribes through the mechanism of phony travel for alleged business purposes. Avon China would claim they were bringing various Chinese government officials (also Wives, Girlfriends and other family members) to locations for business-related travel but in reality the trips were mostly sight-seeing excursions, gambling junkets, a beach vacation and other entertainment which had nothing to do with business purposes. So a trip alleged to be a “site visit/study visit” to the corporate headquarters in New York City and the company’s research and development (R&D) facility in upstate New York became a $90,000, 18-day travel extravaganza to “Vancouver, Montreal, Ottawa, Toronto, Philadelphia, Seattle, Las Vegas, Los Angeles and Washington DC.” (Oh, and one half-day at the company’s upstate New York R&D facility.) Other favorite venues for Chinese government officials and their families were the gambling mecca of Macau, Hong Kong, Hainan Island, Guangzhou, Shenzhen and Sanya. Needless to say, none of these locations had any Avon corporate offices, manufacturing or R&D facilities.

Cash

Always a favorite of bribers everywhere, Avon did not neglect to lay out large amounts of cash. Avon China used a variety of orchestrations to hide these payments including simply stealing it from a (apparently) huge petty cash fund, directing Avon China employees to charge for non-existent expenses and keep the reimbursements from corporate, lying in the books and records by calling such bribe payments as “management expenses-government relations expenses” and even submitting “a handwritten certificate, purportedly from a Chinese government agency, falsely stating that the official would give the funds to the government bureau.”

Payment Through Third Parties

Using an entity identified as “Consulting Company A”, Avon China paid a large number of bribes throughout the period in question. Initially it should be noted that this entity raised numerous red flags that were never investigated or cleared. These began with the fact that it was a Chinese government official who recommended the retention of Consulting Company A to perform ‘lobbying’ services for Avon China. Thereafter the company performed no background investigation into the ownership structure of the company, did not include any compliance terms and conditions in the contract, did not even communicate to this third party of Avon’s Code of Conduct prohibition against bribery of government officials. Beyond these issues, in large part Consulting Company A never performed any legitimate services for Avon China. What Consulting Company A did provide to Avon China was a way to funnel bribe payments to Chinese government officials.

Corporate Connivance in Scheme (AKA The Cover-Up)

While all of the above was bad, one thing which catapulted the Avon FCPA bribery scandal into the realm of seriously bad was the company’s discovery of the bribery scheme and resulting cover-up. According to the Criminal Information for Avon Products, in 2005 a senior auditor in Avon’s internal audit group, “reported to Avon’s Compliance Committee, which was comprised of several senior Avon executives, that Avon China executives and employees were not maintaining proper records of entertainment for government officials” and that an Avon China executive had explained the practice “was intentional because information regarding that entertainment was ‘quite sensitive.’” This led to a Draft Audit Report, reviewed at the highest levels of Avon China and Avon in the US, which concluded that Avon China’s Corporate Affairs Group’s expenses included: “(1) high value gifts and meals that were offered to Chinese government officials; (2) the majority of expenses relating to gifts, meals, sponsorship and travel of substantial monetary value was to maintain relationships with government officials; (3) a third party was paid large amounts of money to interact with Chinese government officials but was not contractually required to follow the FCPA, was not monitored by Avon China, and was paid for vague and unknown services; and (4) the payments, and the lack of accurate, detailed records may violate the FCPA or other anti-corruption laws.”

So what was the company’s response to this information? The internal auditors who prepared the report were required to remove the above language and whitewash the report. Evidence of reviewed misconduct was reduced to two hand-written pages, which were then taken out of China and hand-carried to Avon’s corporate headquarters. All copies of the Draft Audit Report were ordered to be retrieved and destroyed. Finally, as noted in the Criminal Information of Avon China, in January 2007, an Avon executive reported to the Avon Compliance Committee “that the matter reported in 2005 regarding the potential FCPA violations by AVON CHINA executives and employees had been closed as “unsubstantiated” which terminated Avon’s investigation into AVON CHINA’s corrupt conduct.”

Tomorrow we take a look at some of the key lessons to be learned from Avon FCPA enforcement action.

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, 2014The v

Seamus Heaney and Compliance With a Seat at the Table

I have long been fascinated with the Irish poet Seamus Heaney. I came to know him thought his 1999 translation of Beowulf. While I was aware that he had been awarded the 1995 Nobel Prize for Literature, I did not know his work as an Irish poet. However, this was rectified in a piece in the Times Literary Supplement (TLS), entitled “A stay against confusion – Seamus Heaney and the Ireland of his time”, by Roy Foster. In this piece he reviewed the evolution of Heaney’s poetry through the 1960s and 1990s. Foster believed that Heaney’s work in many ways mimicked the growth that “Irish intellectual as well as social and economic life”. Heaney began as a ‘nuts and bolts’ type of poet and moved to become a Yeatsian figure as the national poet of Ireland.

I thought about that growth and Foster’s article when I considered the question of what happens if you seek for something and then actually get it? For instance, you may have wanted a seat at the C-Suite table as a Chief Compliance Officer (CCO) and now you have one. What happens now, for instance in the situation where you find out that your company has decided to enter a new overseas market with a new product offering? The Chief Executive Officer (CEO) who championed you coming onboard with the big boys (or perhaps big girls) team looks down and says, “We need an analysis from the compliance perspective by the end of the week?” Where do you begin?

Obviously there are some preconditions for success such as your company should have a product that you can make and sell overseas for a profit. Further, you should have the time, money and sophistication to develop an international distribution network and you have the home office infrastructure to support a truly international business. Finally, you should have a senior management with at least an appreciation of compliance challenges in the target, with the personnel, technological solutions and internal training to address and meet these challenges. As you begin to think through this assignment you fall back on the four basic questions of (1) Who will we sell to? (2) What are we going to sell? (3) Where will we sell? (4) How will we sell?

Who will we sell to?

For any anti-corruption analysis you need to begin here as the Foreign Corrupt Practices Act (FCPA) applies to commercial relationships with foreign governments or instrumentalities such as state owned enterprises. Will your end using-direct customers be foreign governments or privately owned companies? What if your customers are distributors or other middlemen who will then sell to foreign governments or state owned enterprises? What about licenses; will you need special permits to sell to a foreign government or state owned enterprise or will you need some type of basic permit simply to transact business? If your company is subject to the UK Bribery Act this public/private distinction does not exist.

What are we going to sell?

What is the product or service you wish to take internationally? I will assume your company has done the market studies to ascertain it is a viable commercial concept. If it a product, is it a complete or partial product? Will you manufacture here in the US and only sell internationally or will you manufacture abroad as well? If it is here in the US, what about spare parts and accessories, will you need to obtain any licenses overseas? What about your technology, will that component require any licenses? If you will manufacture outside the corporate offices in the US, how will you assure quality in your supply chain? Conversely, if you manufacture in the US, do your supplier agreements allow you to resell outside the US?

Where will we sell? 

This question may seem more important for export control issues; however it is also important in the anti-corruption world. Obviously this is because certain geographic areas are more prone to corruption than others. A starting place might be the Transparency International-Corruption Perception Index but you can also use tools such as the recently released TRACE Matrix which provides a much broader assessment of corruption indices and give you additional insight into a fuller panoply of corruption risks in a country. In addition to the basic corruption analysis you need to ascertain whether you can even sell your products in a new country, either because of US export regulations or the end using jurisdictions laws. You should also focus on the business culture of a country and whether it is compatible in doing business in compliance with relevant anti-corruption legislation. This will also help you in your search to find any local business partners. 

How are you going to sell?

This is one of the most important questions you can ask under a FCPA analysis. It is because well over 90% of all FCPA enforcement actions involve third parties. If this is your first international sales effort, your company probably does not have an international based employee sales force. This means you will most probably need in-country partners for your target markets. Some of the most basic sales arrangements for third parties are as follows:

1. Agent/Sales Representative – This person or entity is an independent third party from the company. Compensation is usually commission based or combined with a periodic fee plus commission. It is generally viewed as the highest risk from the anti-corruption perspective but you will have a direct relationship with the end-using customer.
2. Distributor/Retailer – This person or entity is an independent third party from the company. Your company will sell to the distributor/retailer who then resells your product. You will have less visibility into the end user and hence a greater export control risk. Consignment is a variation on this model but if you are warehousing you will need to be aware of other US rules such as revenue recognition under US GAAP or local, indigenous rules on storage and warehousing.
3. Consultant – This is also an independent third party who is paid a periodic fee. The fee can be more easily assessed for an hourly or service based rather than simply a commission based fee structure.

There are some other sales arrangements that you may whish to consider. You can acquire a local business and run it as your own company. Of course if you do so, you may buy all of these liabilities, both known and unknown. You can joint venture with another local company. Here you may have the dual problems of less actual control yet the same amount of potential exposure, particularly under the FCPA if you fail to perform the requisite pre-acquisition due diligence and allow any illegal conduct to continue going forward. You can issue a manufacturing license to an in-country manufacturer and allow them to make and then sell your product using your technology. Finally, you can issue a brand license where you license an existing company to put your brand name on your product manufactured by another entity. Of course if you use any of these types of arrangements you will need to go through a full third party management cycle; consisting of a business justification, questionnaire, due diligence, contract and management thereafter.

From the internal control perspective you will need to make sure you have several key compliance related controls in place. This will include the aforementioned vetting of all customers and third parties; appropriate controls over each transaction, including both quotes and contracts; empowered and non-conflicted employees; and finally training and self-auditing. You will need separate controls over payment terms and payment mechanisms and controls to align shipping and export controls. Finally, do not forget the omnipresent segregation of duties and control over the vendor master file.

Lastly, you should focus on your high-risk points in any of the above. These include your full vetting and management of third parties. You should pay attention as to how you became aware of these third party sales representatives. You will also need to pay attention to your freight forwarders and other export control representatives. You will need to be vigilant going forward for outright bribes paid in either cash or other values such as free products, lavish travel, gifts and entertainment, especially if the travel has no business purpose.

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